Efficient Market Hypothesis Introduction The 2008 economic recession and the current European Sovereign Debt Crisis have brought economics to the forefront of public thought perhaps more than anytime since the Great Depression. While the American economic collapse exposed many of the high risk and borderline unethical practices of large-scale investment banking and insurance agencies, an even deeper concern were the structural aspects of government that allowed these practices to occur…
While the extent of the validity of these criticisms remains debated, the efficient-market hypothesis (EMH) has held a pronounced influence on political and academic thought. This essay considers the extent that the market, as Warren Buffet claims, functions under irrational processes, or can be explained in rational terms through the efficient market hypothesis. Outline of the Efficient Market Hypothesis (EMH) In its modern incarnation Professor Eugene Fama first articulated the efficient-market hypothesis in the early 1960s during his time at the University of Chicago Booth School of Business. From an overarching perspective, the efficient market hypothesis theory contends that for investors it is impossible to ‘beat’ the market on a consistent basis. The main reasoning behind this notion is that the market will reflect all available information for the particular investment, such that gaining any sort of edge over other investors is made impossible. This contention does not necessitate that individuals act in rational ways. Indeed, the efficient market hypothesis understands that a number of individuals will both over and under react to available market information. The cumulative impact of these reactions results in market efficiency, as the random reactions will fall proportionally along a normal distribution pattern. In these regards, it’s possible for an individual to be right or wrong about the market, but the market itself is necessarily an accurate reflection of available asset information. Structural Components There are three major versions of the efficient market hypothesis, each of them resting on a different part of a spectrum of efficiency. The first version is the weak-form efficient market theory. Within this perspective all prices on past publically traded assets, including stocks, bonds, and property, already have factored into them all publically available investment information. The semi-strong version of the hypothesis takes this a step further and argues that current asset prices reflect all publically available information and that when new information emerges prices change instantly to reflect this new public information. The third version of the efficient market hypothesis is the strong-form version. The strong-form version of the hypothesis goes even further in that it argues in addition to asset prices immediately reflecting public information, asset prices also instantly reflect insider or otherwise concealed information. Analysis Seminal Literature There are a number of seminal studies that established core elements of the efficient market hypothesis. While Fama first articulated the theory in its modern context, its original formulations were explored as early as the 19th century. Kirman (2009) notes that French mathmetician Louis Bachelier established many of the general tenants of this theory in his ‘Theory of Speculation’ published in 1900. The early years of the 20th century witnessed another prototypical formulation of this perspective in the random walk model; this was a notion that stock prices operated through random steps and as such gaining a long-term predictive edge was ...
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(“Efficient Market Hypothersis Essay Example | Topics and Well Written Essays - 2000 words”, n.d.)
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(Efficient Market Hypothersis Essay Example | Topics and Well Written Essays - 2000 Words)
“Efficient Market Hypothersis Essay Example | Topics and Well Written Essays - 2000 Words”, n.d. https://studentshare.net/finance-accounting/52335-efficient-market-hypothersis.
The author states that three types of efficient markets are based on certain assumptions and certain hypothesis. The weak-form efficient market hypothesis is based on assumption that current prices of stocks represent the full historical information. The technical analysis would not yield superior risk-related amounts of returns.
“A market is efficient with respect to a particular set of information if it is impossible to make abnormal profits by using this set of information to formulate buying and selling decisions”, and such market is called efficient market. Efficient Market Hypothesis postulates that stocks will always be traded at fair value, meaning all the factors both positive and negative are fully factored in the stock prices at all times.
Efficient market hypothesis stipulates that the prices of stocks in the money markets represent summation of all probabilities of all future consequences. The information available in the public domain is assumed to reflect stock prices in the money markets.
Occasionally, due to the availability of certain information, investors will act as if directed in one way or another. The decision to act this way may end up being wrong or right for all investors. “When the price of a stock can be influenced by a “herd” on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally.
Hence, the EMH is of little relevance to corporate managers.’ Explain and discuss this contention. The efficient market hypothesis is a proposition which articulates that the market prices of security are a reflection of available information to the members of public.
Basu illuminates that "in an Efficient Capital Market security prices fully reflect available information in a rapid and unbiased fashion" (1977, p663) This suggests that stock price, at a specific moment, reflects all the information that is available and the events that are announced.
It states that the financial markets are usually efficient in terms of providing the right information to the investors.
It also stipulates that the price of traded assets consists of information that is available for use. The example of traded assets involves; stocks, bonds and the properties.
Indeed, there were several theories and models develop to further increase the understanding on financial markets. The knowledge, however, is subject to various criticisms and judgement. Such process allows the models and theories to be meticulously developed before being accepted.
Investors will therefore make normal profits. According to this hypothesis, any new information that can influence the prices of securities will spread randomly to all investors. The weak form hypothesis argue that the