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Efficient Market Hypothesis
Finance & Accounting
Pages 6 (1506 words)
Efficient market Hypothesis Efficient market hypothesis presumes that market can function exceptionally well in allocating resources. It is a situation where no investor in the money markets can achieve excess profits based on risk-adjustment, if information on the investment is in public domain at the time when making the investment.
The efficient market theory assumes that there are no transaction costs, money market is not segmented and it is easy to enter the money markets. Efficient market hypothesis is explained in three ways. First, there is weak form efficiency. Weak form efficiency stipulates that all past information that is available in public domain is a reflection of stock prices. The prices are considered unbiased and best estimation of security value. It presumes that it is impossible to predict future prices using past information through technical analysis (Pompian, 2006). Therefore, an investor cannot use technical analysis to predict future prices that are likely to give excess profits (returns). Secondly, there is Semi-strong form efficiency. This form of efficiency stipulates that all publicly available information reflects prices of stock. It further states that prices adjust instantly as new information is made available. Fundamental analysis cannot be relied upon to generate excess returns to the investor. Thirdly, there is strong form efficiency. According to this form of efficiency, prices are reflected by both private (insider) and public information. This means that all investors irrespective of whether they have insider information or not, make equal profits on their investments. It further assumes that insider trading laws are usually enforced. ...
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