Efficient market Hypothesis(EMH).pptx

By Nidhi walia
Punjabi University patiala

1. Efficient market Hypothesis(EMH) By : Dr Nidhi Walia Asst Professor, USAM Punjabi University, PAtiala

2. EMH: Introduction According to the Efficient market hypothesis, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. Therefore, it should be impossible to outperform the overall market through expert stock selection or  market timing , and the only way an investor can obtain higher returns is by purchasing riskier investments. The  efficient-market hypothesis  ( EMH ) is a hypothesis in  financial economics  that states that  asset  prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information.

3. The Efficient Market Hypothesis (EMH) essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities . Therefore, assuming this is true, no amount of analysis can give an investor an edge over other investors So, while an investor might get lucky and buy a stock that brings him huge short-term profits, over the long term he cannot realistically hope to achieve a return on investment that is substantially higher than the market average. The major conclusion of the theory is that since stocks  always trade at their fair market value , then it is virtually impossible to either buy undervalued stocks at a bargain or sell overvalued stocks for extra profits. Neither expert stock analysis nor carefully implemented market timing strategies can hope to average doing any better than the performance of the overall market. If that’s true, then the only way investors can generate superior returns is by taking on much greater risk.

4.  The efficient market hypothesis states that stock prices fully reflect all available information and expectations, so current prices are the best approximation of a company’s  intrinsic value . This would preclude anyone from exploiting mispriced stocks consistently because price movements are mostly random and driven by unforeseen events.

5. EMH vs RWH Random walk hypothesis was 1 st   esposed by French mathematician Louis Bachelier in 1900, which states that stock prices are random, like the steps taken by a drunk, and therefore, unpredictable. A few studies appeared in the 1930's, but the random walk hypothesis was studied — and debated — intensively in the 1960's. The current consensus is that the random walk is explained by the efficient market hypothesis. In the EMH, prices reflect all the relevant information regarding a financial asset; while in Random Walk, prices literally take a ‘random walk’ and can even be influenced by ‘irrelevant’ information.

6. The  efficient market hypothesis  ( EMH ) states that financial markets are efficient and that prices already reflect all known information concerning a stock or other security and that prices rapidly adjust to any new information. Information includes not only what is currently known about a stock, but also any future expectations, such as earnings or dividend payments. It seeks to explain the random walk hypothesis by positing that only new information will move stock prices significantly, and since new information is presently unknown and occurs at random, future movements in stock prices are also unknown and, thus, move randomly. Hence, it is not possible to outperform the market by picking undervalued stocks, since the efficient market hypothesis posits that there are no undervalued or even overvalued stocks 

7. Summary information is widely available to all investors; investors use this information to analyze the economy, the markets, and individual securities to make trading decisions; most events having a major impact on stock prices — such as labor strikes, major lawsuits, and accidents — are random, unpredictable events, and their occurrences are quickly broadcast to investors; investors will react quickly to new information

8. Arguments against EMH Market bubbles and crashes

9. Random Walk Theory The Random Walk Theory assumes that the movement in the price of one security is independent of the movement in the price of another security. A “random walk” is a statistical phenomenon where a variable follows no discernible trend and moves seemingly at random. Random Walk Theory as applied to trading states that stock prices have random movement so therefore, any attempt to predict future price movement, either through fundamental or technical analysis, is futile. The implication for traders is that it is impossible to outperform the overall market average other than by sheer chance.  Random walk theory infers that the past movement or trend of a stock price or market cannot be used to predict its future movement.

10. Random walk theory considers fundamental analysis undependable due to the often-poor quality of information collected and its ability to be misinterpreted. Random walk theory considers technical analysis undependable because it results in chartists only buying or selling a security after a move has occurred. Random walk theory claims that  investment advisors  add little or no value to an investor’s portfolio.

11. Forms of EMH Weak Form EMH:  Suggests that all past information is priced into securities. Fundamental analysis of securities can provide an investor with information to produce returns above market averages in the short term, but there are no "patterns" that exist. Therefore, fundamental analysis does not provide long-term advantage and technical analysis will not work. Semi-Strong Form EMH:  Implies that neither fundamental analysis nor technical analysis can provide an advantage for an investor and that new information is instantly priced in to securities. Strong Form EMH.  Says that all information, both public and private, is priced into stocks and that no investor can gain advantage over the market as a whole. Strong Form EMH does not say some investors or money managers are incapable of capturing abnormally high returns because that there are always outliers included in the averages.

12. Weak form of EMH The  weak form  suggests that today’s stock prices reflect all the data of past prices and that no form of  technical analysis  can be effectively utilized to aid investors in making trading decisions. Advocates for the weak form efficiency theory believe that if the  fundamental analysis  is used, undervalued and overvalued stocks can be determined, and investors can research companies'  financial statements  to increase their chances of making higher-than-market-average profits. The basis of "weak form efficiency" is, as the qualifying phrase to all investors by advisers always suggests: "past performance is no guarantee of future results." In other words, future prices cannot be predicted merely by reviewing past prices. So that excess returns - or improved returns - cannot be made over time basing investment strategy on historical share prices or other data.

13. Semi strong form of EMH The  semi-strong form  efficiency theory follows the belief that because all information that is public is used in the calculation of a stock's  current price , investors cannot utilize either technical or fundamental analysis to gain higher returns in the market. Those who subscribe to this version of the theory believe that only information that is not readily available to the public can help investors boost their returns to a performance level above that of the general market. The basis of "semi-strong form efficiency" is that share prices adjust to publicly available new information quickly, and in an unbiased manner, so that no excess returns can be made trading on that information. A test of this is reviewing consistent upward or downward price adjustments after an initial piece of news hits. The movement and direction is believed to indicate if investors interpreted the news in a biased way, which is therefore "inefficient," or unbiased, which is "efficient." 

14. Strong form of EMH The  strong form  version of the efficient market hypothesis states that all information—both the information available to the public and any information not publicly known—is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market. Advocates for this degree of the theory suggest that investors cannot make returns on investments that exceed normal market returns, regardless of information retrieved or research conducted.  In "strong-form efficiency," all share prices reflect the entirety of available information, both public and private, meaning no individual can make excess returns, or "beat the market." This form of market efficiency isn't possible where legal barriers exist to private information becoming public. An example of legal barriers to private information becoming public is insider trading laws. The only way in such an environment for strong-form efficiency is if barriers to private information becoming public are ignored, so that prices reflect private as well as public information.