Financial and Monetary Economics Essay

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Financial and Monetary Economics

‘‘Should we consider the Stock Market an efficient market.’’

In theory the Stock Market is said to be efficient as stock prices should follow a random walk, which, means that stock price changes should be random and unpredictable, If stock prices were predictable then this would prove that the stock market is inefficient as this implies that all available information was not already impounded in stock prices. Hence the notion that stock prices reflect all available information is known as the efficient market hypothesis (EMH). It was Professor Eugene Fama who created the term EMH, in his paper ‘Efficient Capital Markets’ and claimed that in efficient markets
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The strong form of the EMH: Suggests that all information (public and private) is fully reflected in asset prices. This means that not even insider information can be used to beat the market. Therefore the only way to beat the market is by luck and chance only.

It can be noted that all three versions of EMH indicate a role for passive management and no role for active management. As competition makes sure that any new information is reflected in stock prices. Supporters of the EMH believe that active management is a wasted effort and that the expenses are unjustifiable.

“Fama disputed that in an active market of large numbers of well-informed and intelligent investors, stocks will be appropriately priced and reflect all available information. In these circumstances, no information or analysis can be expected to result in out performance of an appropriate benchmark. Because of the wide availability of public information, it is nearly impossible for an individual to beat the market[1]”.

Another Professor who also supports the EMH is Burton Malkeil; he popularized the notion of random walk implication in his book ‘A Walk Down Wall Street’.

“He suggested that throwing darts at the newspaper stock listing is as good a way
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