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Characteristics of market efficiency
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During the 20th century, academic financial economists extensively accepted the efficient market hypothesis. Almost everyone was alleged that stock markets and securities market are highly efficient in response to any new information in the market. It was argued that when information regarding factors influencing market arises, the information spread like wild fire in the market and the prices of stocks adjust accordingly without any delay. This means that neither the fundamental analysis related to analysis of financial information of the company such as earnings, capital stock etc nor the technical analysis related to the analysis of historical performance of the stocks of the company enables the investor either experienced or not to get return over and above the average return of the market by holding any portfolio of stocks with average market risk.
A random walk and efficient market hypothesis are associated because random walk is a term often used in the literature of finance which argues that the further price change in the stocks is independent of any pattern based on the historical trend of price change. The logic behind random walk idea is that the change in the price of stock in any trading session is based on the information available in the market and price change in the next trading session is independent of the change price change in the previous session due to the reason that the next day change in price reflects the impact of information available to them. It is also important to note in consideration to random walk idea is that the information is unpredictable so the change in the stock price is also unpredictable. This means that the change in price of stock during any trading session fully reflects the impact...
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Despite having been around for over one hundred years, people began developing poor judgement when it came to investments in the late nineteenth century. Out of desire to participate in the ever growing popularity of the stock market, people took out large amounts of stock on an installment plan, with money they did not have. As Harry J. Carmen and Harold C. Syrett described in their publication of A History of the American People, as investing in stocks increased in popularity, “the exchange became more of a betting ring.” (Document 5) and “security prices were forced up by competitive bidding rather than by any fundamental improvement in American (business).” (Document 5). The stock market became a game, a challenge that was not fully thought through. This lead to certain businesses getting ahead of others, not due to their success, but because of the uneducated support they were getting from those who knew nothing about the businesses they were investing in, trying to get rich quick. Since those who took out stocks on installment could not pay them off, the stock market eventually collapsed all together. On October 29, 1929, the New York Times published an issue with the headline “STOCK PRICES SLUMP $14,000,000,000 IN NATION-WIDE STAMPEDE TO UNLOAD” (Document 3). Leading up to the ultimate crash, people began to see it coming and at the last second
On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald's, 3M, and other large-cap, generally old-economy stocks. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of
Summing up, earlier empirical research has recommended a relationship between stock market growth and economic development, but is far away from perfect. Even though the connection proposed is a causal one, the majority empirical studies have faced causality indirectly, if at all. Additionally, the majority
In an era of superficial prosperity and indulgence, most Americans “threw all care to the wind” (Danzer, Klor de Alva, Krieger, Wilson, Woloch). Ron Chernow observed that “in the 1920s you could buy stocks on margin. You could put 10 percent down and borrow the rest against your stocks.” Buying on margin is exactly what reflected the American public of the 20s- reckless and optimistic. By using leverage to invest, buyers can maximize their profits through the stock in a bull market ("Buying Stock on Margin"). This idea of using brokers’ money to gain profit for themselves appealed to many Americans. The great bull market that had lasted for six years further instigated irrational exuberance- or the extreme confidence in investors that they overlooked the degrading economic fundamentals- in the American public (Shiller). However, this overvaluation proved to be deadly. Margin loan, like a double-edged sword, eventually stabbed Americans in the back- and stabbed them hard. The
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.
William Sharpe, Gordon J. Alexander, Jeffrey W Bailey. Investments. Prentice Hall; 6 edition, October 20, 1998
We analyzed the market for two weeks to determine when the equity market would turn from a bearish to bullish market. Without a change in the market and a declining bond price, we decided to invest in equities according to our investment strategy, which brought us into the second phase of our portfolio. Therefore, at the beginning of February we bought shares in Sirius, Microsoft, Neon, Washington Mutual, and Nike. As assumed, the equity market continued to plummet decreasing the value of all our stocks except for our Gold Corporation stock.
Howells, Peter., Bain, Keith 2000, Financial Markets and Institutions, 3rd edn, Henry King Ltd., Great Britain.
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.
US News & World Report, Nov. 22, 1999 v 127 i20 p 63 "The great term-paper buying caper."
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.
Following the trend of economy, it is important to investors to understand that strong economy creates strong stock market. To elaborate further, as stock prices are increased by current and future expectations of earnings, thus without a strong economy it would be difficult for the companies to increase and sustain their earnings (Kong 2013). The economy development is usually calculated using the gross domestic product of a countries. On the other hand, a change is the stock price can also cause a major impact to the consumers and investors directly. Hence, a loss in confidence by investors can cause a downturn in consumer spending in the long term, which will also affect the economy’s output (Aysen 2011). The graph below shows the relationship of stock market price (KLCI) and the GDP of Malaysia in 2009. Thus, it can be concluded that the economy and the stock market has a positive relationship.
Johnson, G., Scholes, K., Johnson, G. and Whittington, R. 2011. Exploring strategy. Harlow: Financial Times Prentice Hall.
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.