Market Efficiency Theory - Essay

1458 Words6 Pages
“Every event, no matter how remote or long ago, echoes across all other events.” (Mandelbrot, 2004) Modern financial implications perceive every action/reaction on markets as a result/cause of more complex, mutually dependent events. Studies of these relations began with the simplest ‘random walk’ hypothesis stating that price reactions are unforecastable. It was supported by ‘martingale’ stochastic process. Theoretically it is not possible to fully exist, as there would be no place for speculation and participants would become more like gamblers than stock traders. However it laid foundations to further studies. Use of more sophisticated technology enabled to determine non-random movements and anomalies in asset prices. Suspicious…show more content…
In such situation creating a diversified portfolio is pointless because determining future returns or overvaluation cannot be concluded from any fundamental information available on the market.(Lumby & Jones, 2003). Tracking this pattern, the discounted cash flow analysis is impossible to apply as Net Present Value discount rates would be unreliable. Therefore financial managers could not predict possible returns on similar investments. Long term investment planning consist in NPV however NPV is enabled only under assumption of markets being efficient. Another point which supports EMH ,in view of financial practice, is importance between communicating information to market and receiving a correct security evaluation from it. (Lumby & Jones 2003) In this case of inefficiency, disclosure of significant information could abstractly have less powerful impact on share price than completely not associated announcement . Further influence of EMH on financial practice seems to be active in attitude of investors towards diversified portfolios. As theory implicate “public information cannot be used to earn abnormal returns” (Arnold, 2009) thus traders are becoming more sceptical about outcomes of fundamental analysis. The most reasonable action is to create well-matched selection of securities that would rule out analysis and transaction costs, making returns proportionally greater. The vast majority of investors were convinced by those trends and decided
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