Efficient Market Theories
EFFICIENT MARKET THEORY AND TESTS
Introduction
Market Efficiency
A market is said to be efficient if prices in that market reflect all available information. Market efficiency refers to a condition in which current stock prices reflect all the publicly available information about a security.
Efficient market emerges when new information is quickly incorporated into the share price so that the price becomes information. In other words the current market price reflects all available information. Under these conditions the current market price in any financial market could be the best (unbiased estimate) of the value of the investment.
The Theory of Efficient Market Hypothesis
The Efficient Market Hypothesis (EMH) was first defined by Eugene Fama in his financial literature in 1965.He defined the term "efficient market" as one in which security prices fully reflects all available information.
EMH is the theory describing the behavior of an assumed “perfect” market which states that:
Securities are fairly priced and that their expected returns equal their required return.
Security prices, at any one point, fully reflect all public information available and react swiftly to new information.
Because stocks are fully and fairly priced, investors need not waste time trying to find and capitalize on mispriced (undervalued and overvalued) securities.
Therefore, the market is efficient if the reaction of market prices to new information should be instantaneous and unbiased.
The efficient market hypothesis states that it is not possible to consistently outperform the market by using any information that the market already knows, except through luck. Information or news in the EMH is defined as anything that may affect prices that is unknown in the present and thus appears randomly in the future. Evidence in favor Efficient Market Hypothesis Theory
i. Stock prices are close to random walks ii. Stock returns have low linear correlation iii. Stock returns
Introduction
Market Efficiency
A market is said to be efficient if prices in that market reflect all available information. Market efficiency refers to a condition in which current stock prices reflect all the publicly available information about a security.
Efficient market emerges when new information is quickly incorporated into the share price so that the price becomes information. In other words the current market price reflects all available information. Under these conditions the current market price in any financial market could be the best (unbiased estimate) of the value of the investment.
The Theory of Efficient Market Hypothesis
The Efficient Market Hypothesis (EMH) was first defined by Eugene Fama in his financial literature in 1965.He defined the term "efficient market" as one in which security prices fully reflects all available information.
EMH is the theory describing the behavior of an assumed “perfect” market which states that:
Securities are fairly priced and that their expected returns equal their required return.
Security prices, at any one point, fully reflect all public information available and react swiftly to new information.
Because stocks are fully and fairly priced, investors need not waste time trying to find and capitalize on mispriced (undervalued and overvalued) securities.
Therefore, the market is efficient if the reaction of market prices to new information should be instantaneous and unbiased.
The efficient market hypothesis states that it is not possible to consistently outperform the market by using any information that the market already knows, except through luck. Information or news in the EMH is defined as anything that may affect prices that is unknown in the present and thus appears randomly in the future. Evidence in favor Efficient Market Hypothesis Theory
i. Stock prices are close to random walks ii. Stock returns have low linear correlation iii. Stock returns