...THE EVOLUTION OF STOCK MARKET EFFICIENCY OVER TIME: A SURVEY OF THE EMPIRICAL LITERATURE Kian-Ping Lim Universiti Malaysia Sabah and Monash University and Robert Brooks Monash University Background This paper provides an insight into the empirical literature as pertains the evolution of stock market efficiency over time, with a keen focus on the weak form Efficient Market Hypothesis (EMH). The authors provide a systematic review of the correlation between several financial factors namely: Adaptive Markets Hypothesis (AMH), Efficient Markets Hypothesis (EMH), Evolving Return Predictability, Stock markets and Weak-form EMH. The authors pay keen attention on how return predictability from past price changes is affected by key players and determinants on the stock markets. From the survey they conduct, the posit that the bulk of the empirical studies examine whether the stock market under study is or is not weak-form efficient in the absolute sense, assuming that the level of market efficiency remains unchanged throughout the estimation period. The authors acknowledge that one field that has drawn extensive investigation by scholars and other players alike is the predictability of stock returns on the basis of past price changes. This is partly due to its direct implication on weak-form market efficiency. They find that a vast majority of the literature implicitly assumes the level of market efficiency remains unchanged throughout the estimation period. However, the possibility...
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...1. Explain what efficient market hypothesis is. ` In a simple statement, the Efficient Market Hypothesis (EMH) means that security prices fully reflect all available information (Fama, 1991). There are three forms of EMH. Weak Form EMH Semi-Strong Form EMH Strong Form EMH • All past prices of a stock are reflected in today's stock price. • Technical analysis cannot be used to predict and beat a market. • All public information is calculated into a stock's current share price. • Neither fundamental nor technical analysis can be used to achieve superior gains. • All information in a market, whether public or private, is accounted for in a stock price. • Not even insider information could give an investor the advantage. Adapted from http://www.investopedia.com/exam-guide/cfa-level-1/securities-markets/weak-semistrong-strong-emh-efficient-market-hypothesis.asp#axzz27eAhlXfl The assumptions behind this hypothesis are; 1. A large number of profit-maximising participants analyse and value securities independently. 2. News regarding securities comes to the market randomly and independently. 3. Trading decisions of all the investors adjust security prices rapidly to reflect the effect of new information. . 2. Link it to the idea of the fully revealing rational expectations equilibria. The EMH is the application of Rational Expectations Theory by Muth (1961). Assuming there is only one equilibrium price, it states that outcomes do not differ systematically from what...
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...Efficient Market Hypothesis Efficient Market - Introduction An efficient capital market is a market that is efficient in processing information Assumptions for Market to be Efficient 1. 2. In other words, the market quickly and correctly adjusts to new information In an efficient market, the prices of securities observed at any time are based on “correct” evaluation of all information available at that time In an efficient market, prices immediately and fully reflect all available information Large no. of investors analyze and value securities for profit New information comes to the market in a random fashion 3. 4. Stock Prices adjust quickly to the new information Stock Prices should available information reflect all Definition "In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.“ - Professor Eugene Fama Efficient Market Hypothesis - Forms Efficient Market Hypothesis Weak Form Semi-Strong Form Strong Form The EMH Graphically All information, public & private • In this diagram, the circles represent the amount of information that each...
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...that the market always prices rationally. In fact, market prices are frequently nonsensical.” ------------------------------------------------- This report will analysis the statement by Warren Buffett, and it considers the contrasting evidence on the validity of the observation on the Efficient Markets Hypothesis. The report briefly outlines the forms of the Efficient Market Hypothesis, the report also analysis’s the evidence both seminal and recent on the theory relating to the three forms of the hypothesis. It also examines the theoretical role and motivation of analysts in creating market efficiency; lastly it looks at alternative perspectives on the pricing of securities. Introduction In 1984 Warren Buffett penned an article titled “The Superinvestors of Graham-and-Doddsville”, based on a speech he had given on the occasion of the 50th anniversary of his mentor Ben Graham’s legendary textbook, Security Analysis. In it, Buffett rejected the then growing (and now entrenched) view in academia that markets are ''efficient'' because ''stock prices reflect everything that is known about a company’s prospects and about the state of the economy.'' Warren Buffett argued against EMH, saying the preponderance of value investors among the world's best money managers rebuts the claim of EMH proponents that luck is the reason some investors appear more successful than others. (Hoffman, 2010) This report will either agree with Buffet or somewhat sit on the fence. A market is said...
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...Efficient Market Hypothesis: Examining the Case of South Asian Stock Markets Sharon Prakash Abstract This study examines the relevance of the Efficient Market Hypothesis among emerging stock markets belonging to the South Asian Association for Regional Cooperation (India, Pakistan, Sri Lanka and Bangladesh) and the Global economy. The study employs daily closing prices of eminent market indices from a time period 2004-2013.The stock returns have been subjected to unit root tests such as the Augmented Dickey Fuller test and a panel unit root test. Additionally the existence of random walk for these stock markets has also been examined through the Jarque-Bera statistic. The results indicate information inefficiency in the time period under study for all indices. Investors can therefore predict future prices on the basis of historical information, and receive excessive returns. The results have implications for developing economies wherein the government has to ensure that all asset related information be made public, to curb state interference. Introduction The concept of Efficient Market Hypothesis (EMH) holds special importance in the field of Finance, especially Capital markets. This hypothesis postulates that markets are informationally efficient. This asserts that the price of any security will fully reflect all the information that is available to the investors. That being said, one cannot consistently achieve returns that are excess of the average market returns...
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...Financial Market Definition of 'Financial Market' Broad term describing any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade. Some financial markets only allow participants that meet certain criteria, which can be based on factors like the amount of money held, the investor's geographical location, knowledge of the markets or the profession of the participant. Investopedia explains 'Financial Market' Financial markets can be found in nearly every nation in the world. Some are very small, with only a few participants, while others – like the New York Stock Exchange (NYSE) and the forex markets – trade trillions of dollars daily. Most financial markets have periods of heavy trading and demand for securities; in these periods, prices may rise above historical norms. The converse is also true – downturns may cause prices to fall past levels of intrinsic value, based on low levels of demand or other macroeconomic forces like tax rates, national production or employment levels. Information transparency is important to increase the confidence of participants and therefore foster an efficient financial marketplace. Financial Markets: Capital Vs. Money Markets ...
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...status, and the groups upon whom this theory has appealed to would suggest that it is flawed on many levels and is little more than an argument for deregulation and market capitalism. This opposes its claim to be a useful theory used regularly by those concerned with the effects of accounting policy on the status of the firm. The Premises of Positive Accounting Theory Positive Accounting Theory finds its roots with the Efficient Market Hypothesis (EMH). The EMH was developed by Fama in the 1960’s and is based on economic principles and assumes a perfect market where there is information symmetry and no transaction costs. The semi strong form of EMH argues that capital markets will reflect all information that is publicly available and it is this form that Watts and Zimmerman claim to be predominant. The EMH was used in a study performed by Ball and Brown during the same period. The Ball and Brown study rejected the argument put forward by normative theorists that present accounting results were misleading and irrelevant and stated that historical cost accounting is actually useful (Deegan 2000). This was because their study demonstrated that unexpected accounting earnings produced abnormal returns in capital markets. This was also the case for unexpected poor earnings as they produced abnormal losses in capital markets. This was measured...
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...October 28, 2011 The Efficient-Market Hypothesis and the Financial Crisis Burton G. Malkiel* Abstract The world-wide financial crisis of 2008-2009 has left in its wake severely damaged economies in the United States and Europe. The crisis has also shaken the foundations of modern-day financial theory, which rested on the proposition that our financial markets were basically efficient. Critics have even suggested that the efficient--market–hypotheses (EMH) was in large part, responsible for the crises. This paper argues that the critics of EMH are using a far too restrictive interpretation of what EMH means. EMH does not imply that asset prices are always “correct.” Prices are always wrong, but no one knows for sure if they are too high or too low. EMH does not imply that bubbles in asset prices are impossible nor does it deny that environmental and behavioral factors cannot have profound influences on required rates of return and risk premiums. At its core, EMH implies that arbitrage opportunities for riskless gains do not exist in an *Princeton University. I am indebted to Alan Blinder and to the participants in the Russell Sage Conference on Economic Lessons From the Financial Crisis for extremely helpful comments. 2 efficiently functioning market and if they do appear from time to time that they do not persist. The evidence is clear that this version of EMH is strongly supported by the data. EMH can comfortably coexist with behavior finance, and the insights of Hyman...
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...EFFICIENT MARKETS HYPOTHESIS AND OTHER THEORIES OF PRICING IN FINANCIAL MARKETS Name Course Title/Code Instructor’s Name Date Efficient Markets Hypothesis and other theories of pricing in financial markets Efficient market hypothesis (EMH) is a theory that emerged in the 1960s. It states that it is difficult to predict the market since the price has been set and reflect the current market conditions. It is a disputed and controversial theory. The theory is comparable to other theories of pricing in financial markets. Several strengths and shortcomings emerge through comparison with other theories of pricing (Blinder, et al., 2012). EMH states that no stock is a better buy when compared to others. It is the conclusion that leads to random choices. It is a vital tenet of finance theory. The EMH theory has a basis in other finance theories. It follows the classical theory of asset prices. To determine the connection, a situation where stocks are considered based on good deals. According to the EMH theory, these stocks are worth more than their relative prices. The worth of a stock is the present value of the expected dividends. In this regard, an individual will buy stocks at prices that are below this level. In essence, this is buying stocks that are undervalued assets (Kapil, 2011). Classical theory The classical theory follows the belief that the price of a stock is equal to the best estimate of the stock’s value. This equality means that the undervalued stocks are not real...
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...Chapter 7 - Positive Theory Positive Accounting Theory Philosophy of PAT Million Friedman championed positive theories in economics. He stated that: (part 3 Empirical Research in Accounts of Accounting theory from Jayne Godfrey) The ultimate goal of positive science (i.e. INDUCTIVE) is • The development of a ‘theory ‘ or ‘hypothesis’; • that yields valid and meaningful “Predictions’ • about phenomena not yet “observed”. Consistent with Friedman’s view, Watts and Zimmerman asserts that: The objective of “positive accounting theory” is to “explain” and “predict” accounting practice. • “Explanation” means providing reasons for observed practice. For example, positive accounting theory seeks to explain why firms continue to use historical cost accounting and why certain firms switch between a numbers of accounting techniques. • “Prediction” of accounting practice means that the theory predicts “unobserved phenomena”. Watts and Zimmerman start their book with a fundamental statement of The Role of Theory (Chapter 1).They asserts that the objective of positive accounting theory is to explain and predict accounting practice,(p.2) “Unobserved phenomena” are not necessarily future phenomena; they include phenomena that have occurred, but on which systematic evidence has not been collected. For example – Predicting the reaction of firms to a proposed accounting standard and an explanation of why firms would lobby for and against...
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...Summary Roger Lowenstein thought that the current Great Recession could drive a stake through the efficient-market hypothesis (EMH). Analogously, Jeremy Grantham claimed that the incredibly inaccurate efficient market theory cased a lethally dangerous result that led to current plight. However, the EMH is not responsible for the current crisis. Eugene Fama stated that the prices of securities reflect all known information that impacts their value. The hypothesis implies that the prices in the market are mostly wrong, and it is hard to say whether they are too high or too low. Regulators wrongly believed that financial firms were offsetting their credit risks, while the banks and credit rating agencies underestimated the risk in real estate. EMH is not an excuse by the CEOs and regulators of failed financial firms. After the 1982 recession, the U.S. and world economies entered into a long fluctuations period which called the “Great Moderation”. Risk premiums shrank and individuals and firms took on more leverage. Prof. Robert Shiller collected the data which indicates from 1945 through 2006 the maximum cumulative decline in the average price of homes. This low volatility might lead to the mortgage security composed of a nationally diversified portfolio of loans would have never come close to defaulting. These models led credit agencies to rate these subprime mortgages as “investment grade”. But this assessment was faulty. In fact, never before have home prices jumped that far...
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...In finance, the efficient-market hypothesis (EMH), or the joint hypothesis problem, asserts that financial markets are "informationally efficient". In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made. There are three major versions of the hypothesis: "weak", "semi-strong", and "strong". The weak form of the EMH claims that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. The semi-strong form of the EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information. The strong form of the EMH additionally claims that prices instantly reflect even hidden or "insider" information. Critics have blamed the belief in rational markets for much of the late-2000s financial crisis.[1][2][3] In response, proponents of the hypothesis have stated that market efficiency does not mean having no uncertainty about the future, that market efficiency is a simplification of the world which may not always hold true, and that the market is practically efficient for investment purposes for most individuals.[4] In political science and economics, the principal–agent problem or agency dilemma concerns the difficulties in motivating one party (the "agent"), to act in the best interests of another (the "principal") rather than...
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...Market Efficiency and the Johannesburg Securities Exchange Table of Contents 1. Abstract 3 2. Introduction 4 3. The Johannesburg Securities Exchange 4 3.1. History 4 3.2. Function 5 4. The Efficient Market Hypothesis 5 4.1. Strong From 6 4.2. Semi-strong form 6 4.3. Weak form 7 4.4. Random Walk Hypothesis 8 5. Empirical evidence 9 5.1. Joint Hypothesis Problem 10 5.2. Capital Asset Pricing Model 11 5.3. Empirical evidence on investor overreaction 12 6. Comparisons to international stock markets 13 7. Conclusion 15 9. Bibliography 16 1. Abstract The JSE is a securities exchange based in South Africa and is considered to be the largest on the African continent. More than 400 stocks are traded on the JSE and as a result, it is important that investors are aware of the relevant information regarding stocks, which would enable investors to make sound investments. The Efficient Market Hypothesis is used to ascertain whether certain stocks and their respective prices in a particular market reflect all necessary information, which would illustrate an efficient market (Fama, 1970). Carrado and Jordan (2000) supports the aforementioned statement by affirming that markets are efficient in terms of sources of specific information, on condition that information is not exploited to earn above average returns. Furthermore, Fama (1965) explained the efficiency of markets and their stock prices by analyzing the three forms of...
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...1 EFFICIENT MARKETS HYPOTHESIS Andrew W. Lo To appear in L. Blume and S. Durlauf, The New Palgrave: A Dictionary of Economics, Second Edition, 2007. New York: Palgrave McMillan. The efficient markets hypothesis (EMH) maintains that market prices fully reflect all available information. Developed independently by Paul A. Samuelson and Eugene F. Fama in the 1960s, this idea has been applied extensively to theoretical models and empirical studies of financial securities prices, generating considerable controversy as well as fundamental insights into the price-discovery process. The most enduring critique comes from psychologists and behavioural economists who argue that the EMH is based on counterfactual assumptions regarding human behaviour, that is, rationality. Recent advances in evolutionary psychology and the cognitive neurosciences may be able to reconcile the EMH with behavioural anomalies. There is an old joke, widely told among economists, about an economist strolling down the street with a companion. They come upon a $100 bill lying on the ground, and as the companion reaches down to pick it up, the economist says, ‘Don’t bother – if it were a genuine $100 bill, someone would have already picked it up’. This humorous example of economic logic gone awry is a fairly accurate rendition of the efficient markets hypothesis (EMH), one of the most hotly contested propositions in all the social sciences. It is disarmingly simple to state, has far-reaching consequences...
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...Chapter 16: Market efficiency: Concept of market efficiency An efficient market has been defined as one in which the prices of securities fully reflect all available information. This requires that the reaction of the market prices to new information should be instantaneous and unbiased. If such conditions exist, it will not be possible (except by chance) to employ either past information or a mechanical trading strategy to generate returns in excess of the returns warranted by the level of risk involved. In short, consistent excess profits will not be made. Or in an efficient market it is not possible to consistently make an abnormal return. Statement 1 What would cause a market to be efficient? The main argument in support of efficiency is the existence of a competitive market in which numerous investors are competing in an effort to make abnormal returns. It is suggested that, in such a market, investors will seek information and take immediate action to buy or sell securities based on any new information. As a result, information will be impounded very quickly in market prices. Market efficiency may be improved by an increase in the quantity and quality of information that is made publicly available, and a reduction in restrictions on insider trading. Statement 1 * New information regarding securities comes to the market in random fashion. * Profit maximising investors cause security prices to adjust rapidly to reflect the effect of new information. ...
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