The Contrasting Evidence of the Validity of Efficient Market Hypothesis

Topics: Efficient-market hypothesis, Random walk hypothesis, Fundamental analysis Pages: 4 (1303 words) Published: May 15, 2013
Submitted to: Syed Adil Asghar
Submitted by: Maryam Essam
(01-220102-022)
Class: MBA-3 C
Subject: Financial Management

Bahria University, Islambad Campus
Department of Management Sciences.

The Contrasting Evidence of the Validity of Efficient Market Hypothesis

THE CONTRASTING EVIDENCE OF THE VALIDITY OF THE EFFICIENT MARKET HYPOTHESIS

There is apparently plenty of divergence relating to the validity of efficient market hypothesis (EMH), some academics or financial gurus support efficient market hypothesis while there are some who assert that efficient market hypothesis and random walk theory are flawed concepts in the post-financial crisis era. Beginning with the definition of efficient market hypothesis, it states that the stock market is “efficient” i.e. the existing share prices always reflect complete information of the financial markets to its investors. This theory claims that it is downright impossible to “beat the market” as the stocks are always priced at fair value leaving no room for investors to purchase undervalued stocks or sell stocks at premium prices. Another theory that is consistent with efficient market hypothesis is the random walk hypothesis; it holds that the prices in a stock market cannot be predicted as the price changes have the same distribution and the stock market prices advance by a random walk. This means that future movement of prices cannot be predicted by studying the past movement or trend of the stock market.

The efficient market hypothesis was developed by Eugene Fama in the 1960s and was widely accepted till the 90s, since the “crash of 1987”, “dot com bubble”, “subprime mortgage crisis”; the validity of EMH has become a matter of great concern for investors, analysts and academics. According to EMH, technical analysis (the study of past stock prices to predict future prices) and fundamental analysis (the analysis of financial information like company earnings and asset values to help...
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