Analysis of the Efficient Market Hypothesis

Topics: Stock market, Financial markets, Random walk hypothesis Pages: 15 (3117 words) Published: August 13, 2014
Name: GAO FAN
Student Number: 139030647
Programme Title: Analysis of the Efficient Market Hypothesis Module Title: FOUNDATIONS OF FINANCIAL ANALYSIS AND INVESTMENT (MN7022) Assignment Question: Critically review and discuss the concept of market efficiency and empirical approaches to test for it. Words number: 2994

Analysis of the Efficient Market Hypothesis

INTRODUCTION
The study of “efficient market hypothesis” is originate from Louis Bachelier (1900), he studied the “Brownian motion” and the randomness of the stock price change from the perspective of random process and he found that discounted value reflected in market prices that no matter in the past, present or in the future (Lim & Brooks, 2009). With the use of computer, Kendall (1953) finds that the randomness of stock price changes by the commodity prices and stock prices in Britain and the United States (Lim & Brooks, 2009). Later, Robert (1959) proves that there is no difference between a sequence from the random sequence and the share price of the United States (Lim & Brooks, 2009). In 1964, Osborne puts forward the “random walk theory”, he believes that the change of stock price is similar to the molecular chemistry “Brownian motion” which means that the movement of the particles that suspended in a liquid or gas is continual and chaotic, and that means the change of stock price is unpredictable (Lim & Brooks, 2009). In 1970, Eugene Fama thinks that there is no “memory” of yield sequence of the stock price in statistics and inventors cannot predict its future direction based on the historical prices then Fama presents the efficient market hypothesis in 1970 (Lim & Brooks, 2009). The definition of the efficient market is that if the prices fully reflect all available information in a securities market that is called the economic market (Dimson & Mussavian, 1998). Refers to the efficient market hypothesis theory, the security price can reflect all relevant security information sensitively, timely and accurately (Dimson & Mussavian, 1998). moreover for investors the securities information which has reflected in the stock prices is not available for their research which is in order to get more profit and this means that investors cannot get any information resources or analyze these information to make trading decisions to get extra benefits (Dimson & Mussavian, 1998). However, the efficient market theory is still questioned by a variety of new theories and the discussion about the validity of the capital market and the rationality of the investment decision will be more intense (Chordia et al, 2008).

This article is mainly discussing the concept of market efficiency and empirical approaches to test for it. In addition to analyze the strength and the weakness of the efficient market theory. This article is divided into four parts. The first part is illustrating the concept of the efficient market hypothesis. Then it will discuss three forms of market efficiency and test them. The third separation is analyzing meanings and limitations of the efficient market hypothesis theory. Finally, it will conclude the principal viewpoints and proposes some recommendations.

EFFICIENT MARKET
There are two kinds of definition of the economic market. One is the internally efficient markets that also called operationally efficient markets which is mainly measure the cost of trading when investors buy and sell securities such as the procedure fee from securities firm, the spread between commission and stock jobbery and so on (Jordan, 1983). The other is the externally efficient market that also called pricing efficient market which discusses whether the price of securities rapidly reflect all information which related to the price (Malkiel, 2003). These information includes all publicity available information about companies, industry, domestic and the world economy in addition include some internal private nonpublic information from individuals and groups (Laffont...

References: Andersen, T.M., 1983. Some implications of the efficient capital market hypothesis. Journal of Post Keynesian Economics, 6(2), pp.281-294.
Chordia, T., et al, 2008. Liquidity and market efficiency. Journal of Financial Economics, 87, pp.249-268.
Dimson, E., & Mussavian, M., 1998. A brief history of market efficiency. European Financial Management, 4(1), pp.99-103.
Laffond, J.J., & Maskin, E.S., 1990. The efficient market hypothesis and insider trading on the stock market. Journal of Political Economy, 98(1), pp.70-93.
Laffer, A.B., & Ranson, R.D., 1978. Some practical applications of the efficient-market concept. Financial Management, 7(2), pp.63-75.
Lee, C.C., et al, 2010. Stock prices and the efficient market hypothesis: evidence from a panel stationary test with structural breaks. Japan And The World Economy, 22(1), pp.49-58.
Lims, K.P., & Brooks, R., 2009. The evolution of stock market efficiency over time: a survey of the empirical literature. Journal of Economic Surveys, 25(1), pp.69-108.
Malkiel, B.G., 2003. The efficient market hypothesis and its critics. Journal Of Economic Perspectives, 17(1), pp.59-82.
Mayer-Sommer, A.P., 1979. Understanding and acceptance of the efficient markets hypothesis and its accounting implications. The Accounting Review, LIV(1), pp.88-106.
Jordan, J.S., 1983. On the efficient markets hypothesis. Econometrica, 51(5), pp.1325-1343.
Timmermann, A., & Granger, C.W.J., 2004. Efficient market hypothesis and forecasting. International Journal Of Forecasting, 20(1), pp.15-27.
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