Efficient Market Theory and Behavioural Finance Essay

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.

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

The Efficient Market Hypothesis (EMH) that was first proposed by Fama (1965, 1970) is the cornerstone of the modern financial economic theory. The EMH argues that the market is efficient and asset price reflects all the relevant information concerned about its return. The genius insight provided by the EMH has changed the way we look at the financial crisis thoroughly. However, the confidence in the EMH is eroded by the recent financial crisis. People can not help to ask: if the market is efficient and the price of assets is always correct as suggested by the EMH, why there exists such a great bubble in the financial market during the recent financial crisis?

According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. Thus, portfolio managers should find it impossible to outperform the overall

The premise of an efficient market is that stock prices adjust accordingly as information is received. The speed and accuracy of the pricing changes are a reflection of the strength of the market efficiency, where in theory a perfectly efficient market will re-adjust prices immediately and precisely with new information. The efficient market hypothesis aligns with beliefs about whether technical and fundamental analyses are useful in making investment decisions or whether a passive approach is appropriate. In a perfectly efficient market, these types of analyses are not able to predict stock price trends (based on market inefficiencies or price abnormalities) which could assist in portfolio positioning or investment management. However, some investors belive that the market pricing is not precise and that there are timing windows and pricing trends that can be identified through analysis of past performance and finding price abnormalities where all information is not correctly reflected in the stock price (Hirt, Block and Basu, 2006).

Under the idea that markets are efficient, stock prices reflect new information quickly and accurately. Furthermore, Morningstar (n.d.) contributes details on the strongest supportive theory of efficient markets, EMH exists in three forms: weak, semi-strong and strong. The hypothesis calls for the existence of informationally efficient markets, were current stock prices reflect all information, and attempts to outperform the market will only come in the form of riskier investments. Also, because of a large number of independent investors actively analyzing new information simultaneously as it enters the market, investors react accordingly and is immediately reflected in the stock

Even though we made profits in the last week of our trading game, we were still unable to compensate for our total losses incurred. Previously, we had the mind-set that the stock market was far simpler; people buy shares in the hopes of making money. Some people buy and sell often for speculation purposes, while others are long term investors. Sometimes people make a lot of money very quickly, and sometimes people lose a great deal just as fast.

sider BACKGROUND Efficient market theory examines how accurately stock prices signal resource allocation alloc and fully reflect all available information. Fama (1970) introduced the efficient market hypothesis stating there are three forms of efficiency: weak, semi strong, and strong. A market semi-strong, that incorporates all historical information is said to be weak form efficient, while one that responds to all publicly available informatio is semi-strong efficient. In a semiinformation -strong efficient market, prices instantly change to reflect publicly available information. A strong form market, strong responds to all information, both public and private. The hypothesis claims that achieving above average returns on a risk adjusted basis is impossible (Fama 1970). (Fama, The lowest level of market efficiency, weak form, states that the market only reacts to historical information. This means that no one can earn above normal returns based on published historical information; however, the market does not quickly react to new public or private information. It may be possible then, in a weak form efficient market, to obtain abnormal returns form using either new publicly available or private insider information (Fama 1970). (Fama, A semi-strong form market is more efficient that a weak form, as it reacts to publicly strong available new information quickly and share prices adjust to reflect the market’s reaction. share Obtaining

The efficient-market hypothesis (EMH) is one of the well-known methods for measuring the future value of stock prices. According to this hypothesis, the market is efficient if its prices are formed on the basis of all disposable information. According to EMH if there is a possibility to predict the future price of shares, that is the first sign of an inefficient market.

When establishing financial prices, the market is usually deemed to be well-versed and clever. In a stock market, stocks are based on the information given and should be priced at the accurate level. In the past, this was supposed to be guaranteed by the accessibility of sufficient information from investors. However, as new information is given the prices would shift. “Free markets, so the hypothesis goes, could only be inefficient if investors ignored price sensitive data. Whoever used this data could make large profits and the market would readjust becoming efficient once again” (McMinn, 2007, ¶ 1). This paper will identify the different forms of EMH, sources supporting and refuting the EMH and finally

The efficient market hypothesis states that financial markets are profitable and that the prices in the stock market already embed all familiar information regarding a stock or other security and that the prices adjust quickly to new information which includes current and future expectations about a stock. It further explains that if all needed information concerning the investment is known, it will be difficult for any investor to outperform the market since he/she will be working with the same information as everyone else. Also, that it is impossible to consistently beat the market by stock-picking.

The more efficient the capital market is, the more likely the market will find its highest risk adjusted return. The efficiency of the capital markets is the “glue” that bonds the present value of a firm’s net cash flows,

Efficient Market Hypothesis has been controversial issues among researcher for decades. Until now, there is no united conclusion whether capital markets are efficiency or not. In 1960s, Fama (1970) believed that market is very efficient despite there are some trivial contradicted tests. Until recently, both empirical and theatrical efficient market hypothesis was being disputed by behavior finance economist. They have found that investor have psychological biases and found evidences that some stocks outperform other stocks. Moreover, there are evidences prove that market are not efficient for instance financial crisis, stock market bubble, and some investor can earn abnormal return which happening regularly in stock markets all over the world. Therefore, the purpose of this essay is to demonstrate that Efficient Market Hypothesis in stock (capital) markets does not exist in the real world by proofing four outstanding unrealistic conditions that make market efficient: information is widely available and cost-free, investor are rational, independent and unbiased, There is no liquidity problem in stock market, and finally stock prices has no pattern.

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

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.