Efficient Market Hypothesis

One of the worst sayings in the entire English language is “opposites attract”. It is a cheap and “easy-way-out” excuse that uses the science of magnetism and energy to explain human emotions like love, and frankly, it is false. In romance, it is nearly impossible to be attracted to someone in a way that is not surface beauty if two people are just too different. Things like political views, food preferences, even sleeping patterns can be detrimental if they are too different. In saying that, it is easy to deduce that most people are not fond of the person they consider their “opposite”, and the same goes for characters in film or literature. For instance, in The Crucible by Arthur Miller, there are many examples of pairs that may seem like

The Efficient-Market Hypothesis (EMH) states that it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.

It was previously assumed that economic investors and regulators (agents) utilised all available information and thus market prices were a reflection of this information with assets representing their fundamental value, encouraging the position that agents’ actions were rational. The 2007-2008 Global Financial Crisis (GFC) is posited to have originated from the notion that all available information was utilised, causing agents to fail to thoroughly investigate and confirm “the true values of publicly traded securities,” leading to a failure to register the presence of an asset price bubble preceding the GFC (Ball 2009).

Capital markets provide a function which facilitates the buying and selling of long-term financial securities to increase liquidity and their value, Watson & Head (2013). Hence, the Efficient Market Hypothesis (EMH) explains the relationship that exists with the prices of the capital market securities, where no individual can beat the market by regularly buying securities at a lower price than it should be. This means that in order to be an efficient market prices of securities will have to fairly and fully reflect all available information, Fama (1970). Consequently, Watson & Head (2013) believe that market efficiency refers to the speed and quality of how share price adjusts to new information. Nevertheless, the testing of the efficient markets has led to the recognition of three different forms of efficiency in which explains how information available is used within the market. In this essay, the EMH will be analysed; testing of EMH will show that the model does provide strong evidence to explain share behaviour but also anomalies will be discussed that refutes the EMH. Therefore, a judgment will be made to see which structure explains the efficient market and whether there are some implications with the EMH, as a whole.

The efficient markets theory, according to NASDAQ (n.d.) is the, “Principle that all assets are correctly priced by the market, and that there are no bargains,” (para. 1). This theory implies that supply and demand dictate the reasonable market value for products. Without high demand, the supply will be greater and prices will be lower. Respectively, as demand increases so do the prices until the supply and demand are at equilibrium.

Edgar Allan Poe and 'The Black Cat' 'The Black Cat' is a short story written by Edgar Allan Poe. Poe was born in 1809, died at the age of 40 in 1849, and was an important contributor to the American Romantic movement. His work has also been described as mystery, macabre, and Gothic. In addition to writing short stories and poems, Poe also worked as a literary critic.

considered to be linked to stock prices. Dilon and Owers (1997) argues that, if the

According the definition of EMH, the price which shown on the stock market already were the best results that shows the company’s operating ability. Therefore, it does not matter how much effort made by the stock firm and investor, and how cautious they are. Information already reacted in the stock prices, whether it is an expensive stock or a cheaper one. It seems that how much information could be reflected in price might the distinction of different form of market efficiency. Roberts (1967) had clearly defined the difference between the weak form, semi-strong form, and strong, and it further summarised by Fama (1970) to define the information efficiency, which is: “A market in which prices always ‘fully reflect’ available information is called ‘efficient’”. In the fact that several form market efficiency act in EMH indicates that does those forms real acts in the capital market should be analysed and proved.

It is believed that Efficient Market Theory is based upon some fallacies and it does not provide strong grounds of whatever that it proposes. More importantly the Efficient Market theory is perceived to be too subjective in its definition and details and because of this it is close to impossible to accommodate this theory into a meaningful and explicit financial model that can actually assist investors in making the investment decisions (Andresso-O’Callaghan, B., 2007).

Efficient capital market “It was generally believed that securities markets were extremely efficient in reflecting information about the stock market as a whole” (Fama 1970). To extent that when there is new information about stock rise, the news was dispersed immediately and it affects the security 's price at that time.

It can fairly be said that an Investor considering an investment decision (whether to purchase, sell or hold stock) in publicly traded company acts on the basis of extensive information which is available by corporation to him until the last moment of his investing decision and try to determine the fair price of corporate stock. In the light of continuous creation of a particular impression of corporate affairs by the corporation, new information by corporate can vanish the importance of previous available information to investor. In the scenario only one kind of investors can get advantage over others, who is either very close to corporate operation (corporate officers) or can access nonpublic price-sensitive information to corporation

Last but not least important, an efficient capital market is one in which stock prices fully reflect all available information. However, the paradox is that since information is reflected in security prices quickly, knowing information when it is released does an investor little good. Furthermore, it is impossible to create a portfolio which would earn extraordinary risk adjusted return. As a consequence, all the technical and fundamental analysis are useless, no one can consistently outperform the market, and new

In this literate review the most important papers about explaining stock returns from 1952, when Markowitz came up with Modern Portfolio Theory, till around 2011 will be discussed. As stated in Chapter 2, Jack Treynor was one of the first economists that started to work on the CAPM model. When he developed the CAPM in 1961, there was no way yet to fully test it. Because there were no samples large enough or of sufficient quality, the real testing of the CAPM started in 1970. In 1973, the world was shown the famous Black and Scholes options pricing model. One of the first studies that gave a different answer than the CAPM was the research by Basu (1977). While he agrees with the Efficient Market Hypothesis, Basu reaches another

As Chapter 10 questions, if further evidence continues to surface that capital markets do not always behave in accordance with the efficient market hypothesis, then should we reject the research that has embraced the EMH as a fundamental assumption? In this regard we can return to earlier chapters of this book in which we emphasised that theories are abstractions of reality. Capital markets are made of individuals and as such it would not (or perhaps, should not) be surprising to find that the

“In an efficient market, security (example shares) prices rationally reflect available information” (Arnold 2005, p.684). The efficient market hypothesis