Analysis of Capital Market Efificiency and the Efficient Market Hypothesis

2757 Words6 Pages
bulb-icon

Recommended: Market efficiency theory

Capital market efficiency is concerned with assessing the movements of security prices over different time horizons. In this paper, I will briefly discuss capital market efficiency and then finish with an extensive discussion of the Efficient Market Hypothesis (EMH), which is a leading theory in explaining some of the major reasons for fluctuations in security prices. From this perspective, we will examine the three forms of efficiency, supporting and opposing arguments of the EMH, alternative theories, and potential modifications to the model.

Capital Market Efficiency

The subject of market efficiency is a rich one. Some contend that it is a subject with many conflicting views about how financial markets react. Others contend that the subject is a direct reflection of the way markets should respond given that all participants are playing a “fair game”. Furthermore, there are three important characteristics about capital markets that should be noted. In any market, irrespective of the degree of efficiency, we know that relevant information has the capability of shifting a security’s price. The second point is that it is assumed that the majority of stock market participants are well equipped to compete with each other for those options with the highest returns. Finally, there is the possibility of finding stocks prices that are incorrectly priced.

The characteristics listed above are not intended to be an exhaustive list, but they allow us to make some important generalizations about the way stock prices behave. Given the fact that information causes market prices to move, this allows us to arrive at some very important questions in modern finance. How fast do financial markets react to new information? If markets do react qui...

... middle of paper ...

... Efficent Markets. The Journal of Finance, 34.

Hagin, R. (1979). Modern Portfolio Theory. Dow Jones-Irwin.

Kristoufek, L. (2012). Fractal Market Hypothesis and The Global Fincial Crisis: Scaling, Investment Horizons, and Liquidity. Advances in Complex Systems, Vol.15, 1-13.

Lo, A. W. (2007). Efficient Market Hypothesis. In L. Blume, & S. Durlauf, The Ne Palgrave: A Dictionary of Economics. New York: Palgrave McMillan.

McGraw Hill. (2013, 3 30). Sample Chapter 8. Retrieved from http://highered.mcgraw-hill.com/sites/dl/free/007338240x/773409/Sample_Chapter_8_New.pdf

Phillips, G. (2014, March 30). Capital Market Efficiency. Retrieved March 30, 2014, from http://www.rhsmith.umd.edu/faculty/gphillips/courses/Bmgt640/Effic.pdf

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2013). Fundamentals of Corporate Finance, tenth edition. New York: McGraw-Hill Irwin.

Show More
Related

  • Critically assess the Pecking Order Theory of Capital Structure

    1779 Words  | 4 Pages

    ... Capital, Corporation Finance and the Theory of Investment", The American Economic Review, vol. 48, no. 3, pp. 261-297.

    Read More

  • The Efficient Market Hypothesis

    740 Words  | 2 Pages

    Many people believe the efficient market hypothesis is inefficient and Bloomfield presents an alternative to this hypothesis. Bloomfield posits the meaning of costly statistics is not fully revealed in the market. Some investors put more importance on some statistics rather than others which indicates that some statistics are less exposed in market prices. IRH essentially extends EMH by identifying extraction costs of statistics from publicly available data.

    Read More

  • The Cost of Equity Capital and the Capital Asset Pricing Model

    1469 Words  | 3 Pages

    When discussing the cost of equity capital, or the rate of return required by investors for their share expenses, there are three main models widely used for analyzation. These models are the dividend growth model, which operates on the variable of growth and future trends, the capital asset pricing model (CAPM), which operates on the premise that higher returns are a result of higher risk, and the arbitrage pricing theory (APT), which has a more flexible set of criteria than CAPM and takes advantage of mispriced securities

    Read More

  • Are Theories of Dividend Payment Applicable in the Real World

    1490 Words  | 3 Pages

    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.

    Read More

  • The Efficient Market Hypothesis

    1830 Words  | 4 Pages

    2 (1970): 383–417. i.e. a. Fama, Eugene F. “Efficient Capital Markets II.” Journal of Finance 46, no. 1 (September, 2011). 5 (1991): 1575–1617.

    Read More

  • Portfolio Analysis and Investment

    987 Words  | 2 Pages

    William Sharpe, Gordon J. Alexander, Jeffrey W Bailey. Investments. Prentice Hall; 6 edition, October 20, 1998

    Read More

  • Home Depot & Capital Structure

    987 Words  | 2 Pages

    Berk, J., & DeMarzo, P. (2011). Corporate finance: The core, second edition. (2nd ed.). Boston, MA: Prentice Hall.

    Read More

  • Efficient Market Hypothesis

    790 Words  | 2 Pages

    For a market to be considered efficient it means that at any given time market prices will fully reflect all available information. If this holds true, it means that it would be impossible for investors to beat the market, as securities would always trade at their fair value making fundamental and technical analysis ineffective. Investors would only be able to obtain normal rates of return in an efficient market. This idea is captured in the Efficient Market Hypothesis (EMH) that was thought up by Eugene Farma in his Ph.D. dissertation in the 1960s. As part of the EMH there are three possible levels of efficiency. These include weak, semi-strong, and strong form. In the weak form of market efficiency it is assumed that all past prices and past public information of a security are reflected in the securities current price. In the semi-strong form of market efficiency it is assumed that all public information about a security is reflected in it’s current price and the current price instantly adjusts to new information. Lastly, there is strong form efficiency where it is assumed that all information, public and private, is instantly reflected in the price of a security. It is very difficult to conclude that the U.S. market falls perfectly into one of these three categories because there are various examples of the market acting, or not acting, like each of the forms.

    Read More

  • Essay On Capital Asset Pricing Model

    1344 Words  | 3 Pages

    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...

    Read More

  • Impact Of Stock Split On The Stock Return

    1771 Words  | 4 Pages

    Market efficiency signifies how “quickly and accurately” does relevant information have its effect on the asset prices. Depending upon the degree of efficiency of a market or a sector thereof, the return earned by an investor will vary from the normal return.

    Read More

  • Exhange Risk Faced by Multinational Corporations (MNCs)

    1553 Words  | 4 Pages

    Brealey, Richard A., Marcus, Alan J., Myers, Stewart C. 1999, Fundamentals of Corporate Finance, 2nd edn, Craig S. Beytien, USA.

    Read More

  • A Random Walk Down Wall Street

    3851 Words  | 8 Pages

    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.

    Read More

  • The Efficient Market Hypothesis

    774 Words  | 2 Pages

    The efficient market hypothesis has been one of the main topics of academic finance research. The efficient market hypotheses also know as the joint hypothesis problem, asserts that financial markets lack solid hard information in making decisions. Efficient market hypothesis claims it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information . According to efficient market hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments . In reality once cannot always achieve returns in excess of average market return on a risk-adjusted basis. They have been numerous arguments against the efficient market hypothesis. Some researches point out the fact financial theories are subjective, in other words they are ideas that try to explain how markets work and behave.

    Read More

  • Cash Management

    1080 Words  | 3 Pages

    Block, S. B., & Hirt, G. A. (2005). Foundations of financial management. (11th ed.). New York: McGraw-Hill.

    Read More

  • Financial Theories And Strategies

    1533 Words  | 4 Pages

    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.

    Read More

More about Analysis of Capital Market Efificiency and the Efficient Market Hypothesis

Open Document