1. INTRODUCTION
The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to explain human investors’ behaviors.
2. MAIN BODY
A generation ago, it was generally believed that security markets were efficient in adjusting information about individual stocks and stock market as a whole (Malkiel, (2003)). However, we cannot deny the efficient market hypothesis has several paradoxes.
In the first place, a main theoretical cornerstone for the EMH to be a consequence of equilibrium in capital markets is that markets are always rational. This is against the realism. Even if the foregoing assumption turn out to be entirely possible, many recent studies have concluded that rationality is not always a realistic assumption as investors in many cases engage in irrational investment (Kahneman and Riepe, (1998)).
Second, the efficient market hypothesis cannot explain market anomalies. These market anomalies include the pricing/earnings effect, the size and January effect, the monthly effect, holiday effect and the weekend effect. These anomalies indicate either market ineffici...
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Fama propounded EMH, in 1965, stating that provided all available information is used, market prices will reflect reasonably accurate approximations of the inherent present value of securities; the employment of this information would render agents’ actions rational. Ball expands on this by suggesting that competitive markets lead to costs falling in line with the employment of information.
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 evaluating if the EMH applies to mergers.
Efficient market hypothesis was developed by professor Eugene Fama at the University of Chicago Booth School Of Business as an academic concept of study through his published Ph.D. thesis in the early 1960s . Fama proposed two crucial concepts that have defined the conversation on efficient markets in his thesis. The efficient market hypothesis was the prominent theory in the 1960s, Fama published dissertation arguing for the random walk hypothesis to support his efficient market theory. “Fama demonstrated that the notion of market efficiency ...
Ross, S.A., Westerfield, R.W., Jaffe, J. and Jordan, B.D., 2008. Modern Financial Management: International Student Edition. 8th Edition. New York: McGraw-Hill Companies.
In summary, investors on the whole are rational and contribute to an efficient market through prudent investment decisions. Each investor?s optimal portfolio will be different depending on the feasible set of portfolios available for investment as well as the indifference curve for that particular investor. Lastly, risk free borrowing and lending changes the efficient set and gives the investor more opportunities to either get a higher expected return with the same amount of risk or the same amount of return with less risk.
The stock market’s movements are generally consistent with rational behaviour by investors. There is no need to invoke fads, animal spirits, or irrational exuberance to understand the movements of the market.’ Discuss in relation to the information technology bubble and its collapse. & nbsp ; & nbsp ; & nbsp ; & nbsp ; & nbsp ; Introduction In a perfectly efficient market, it is assumed that all investors have access to all available information of future stock prices, dividend payoffs, inflation rates, interest rates and all other economic factors that affect the present prices of stocks. All investors are perfectly rational and choose to invest in stocks which will have a positive payoff. Therefore, all financial assets must always be priced correctly.
...e efficient. But some markets are more efficient than others. And in markets with substantial pockets of predictability, active investors can strive for outperformance. Peter Bernstein concludes that there is hope for active management: 'the efficient market is a state of nature dreamed up by theoreticians. Neat, elegant, even majestic, it has nothing to do with the real world of uncertainty in which you and I must make decisions every day we are alive.'
According to Perold (2004), ‘CAPM can be served as a benchmark for understanding the capital market phenomena that cause asset prices and investor behavior to deviate from the prescript...
Schwert, G.W. (2001). Anomalies and Market Efficiency. In: G. Constantinides et al. (Eds). Handbook of the Economics of Finance, Chapter 17. North Holland: Amsterdam.
among numerous users. The roles of the stock market are mainly to facilitate and encourage the mobilization of funds, direct them towards efficient economic activities, provide adequate liquidity for investors and encourage the creation of large-scale enterprises, The Kuala Lumpur Stock Exchange Index (CI) is the most popular indicator of the Kuala Lumpur stock market performance. The CI represents share prices of 100 Corporations. These companies are chosen because their operations cover a broad spectrum of economic performance in Malaysia and more significantly reflect stock market activities with fair accuracy, Stock prices depend on the supply and demand for the stock, it causes by the factors that stock prices to be more volatile is limited supply of new issues despite of strong demand for the stocks. This restriction of supply leads to more price fluctuations, which are common to all stock markets. However, two things prevent an infinite price increase in the stock market. Firstly, the amount of money available in any country is finite. As the bull market proceeds, more and more of the country’s savings are invested in the stock market and eventually the people involved might face liquidity...
Dalton, John M. How the Stock Market Works. New York: New York Institution of Finance, 1993.
Fama, E. (1970). Efficient capital markets: A review of theory and empirical work. Journal of finance, Vol. 25, pp. 383-417.
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
In the modern world, financial markets play a significant role, with huge volumes of everyday dealings. They form part of contemporary economic lifestyle and determine the level of success of many people. Humans have always been uncertain of what the future holds and thus, tried to forecast it. The forecast of course cannot omit the likelihood of “easy money” by forecasting the prices of equity markets in the future.
This paper will define and discuss five financial theories and how they impact business decisions made by financial managers. The theories will be the Modern Portfolio Theory, Tobin Separation Theorem, Equilibrium Theory, Arbitrage Pricing Theory (APT), and the Efficient Markets Hypothesis.