Efficient Market Hypothesis Summary

2110 Words Sep 28th, 2011 9 Pages
Efficient Market Hypothesis
Ob 1: What is meant by an efficient market?
• Efficiency can be defined under many context, for example, how efficient is a machinery will depend on how many inputs are required to produce a certain amount of output, the less input used, the more efficient the machinery is.
• A financial market is said to be efficient if asset respond to relevant information instantaneously (or promptly) and accurately so that no one is able to use information that is already known by the market to earn abnormal returns net of transaction costs and should not deviate from its fundamental true & fair price for a long period of time.
• By abnormal, it means the return net of transaction costs is more than justified by its
…show more content…
A TRIN ratio > 1 indicates net selling pressure and the market is considered as bearish. A TRIN ratio < 1 indicates net buying pressure and the market is considered as bullish.
• Proponents of market efficiency (or academics) would say that technical analysis is a waste of time and cannot result in abnormal profits. This is because in a weak form, semi-strong or strong form efficient market, share prices should have already reflected historical price and volume data, and no-one can earn an abnormal return from strategies based in this information. Thus, we could also say that technical analysts or chartists do not believe in any form of market efficiency.
• Evidence for weak form EMH: include any finding that trading strategies based on past price & volume data cannot be used to earn abnormal returns consistently (can only be used to support the weak form EMH but not other 2 forms). For example, Ball (1978), have suggested that the trading rules that result from technical analysis e.g. filter rule, can hardly beat a simply buy and hold strategy after taking transaction costs into account.
• Anomalies (Evidence against the weak form EMH): Overreaction hypothesis suggests that we overreact to unexpected and dramatic new events. Findings by Choper, Lakonishok & Ritter (1992) on overreaction effect:
- After constructing two types of portfolios based
Open Document