The Origin Of The Efficient Markets Hypothesis Essay

The basis of Efficient Market theory is considered to have a gap in theory and practice that

This financial crisis has eroded the confidence in the EMH. The validity of the EMH and the existence of the efficient market are questioned broadly. If asset prices are always correct and reflect all the relevant information concerning about its return just as the EMH has suggested, why there exists such a great bubble in the financial market during the recent financial crisis? If the market is efficient, why the market fails to predict the collapse of Lehman Brothers, Bear Stern and other large financial institutions? Overall, the EMH fails to answer such questions. Moreover, the EMH also performs poor in explaining other financial crisis. One example is the Tulipmania that occurred in the 17th century. The prices of the tulip bulbs reached extremely high level which seriously deviates from its fundamental value that was suggested by the EMH. This apparent bubble is contradicted with the prediction of the EMH. In fact, the explaining power of the EMH becomes pale when confronting financial crisis.

What is the efficient-markets hypothesis? What does it imply about the role of portfolio managers?

This concept impacted Warren Buffett by having the right mental attitude towards the market fluctuations that will conduct the most success. He states that Mr. Market is there to guide you not serve you (Farnam Street). It is your choice to ignore him or to take advantage of what he has to offer. The concept impacted the strategies of Berkshire Hathaway by achieving the companies investment success by having good investment judgement along with insulate Mr. Market’s behavior (Farnam

Another concern relates of insider trading of market efficiency of stock market. In his classical study Fama (1970) proposes efficient market Hypothesis, which suggests that stock price reflects all available information (historical price, public and private) in

information in the previous prices. In short, they simply imply that in the long run, no one

After some time researching I found a really well explained definition that says, “The stock market is the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets Also known as the equity market the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors a slice of ownership in the company. The stock market makes it possible to grow

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

Efficient Market Hypothesis has been controversial issues among researcher for decades. Until now, there is no united conclusion whether capital markets are efficiency or not. In 1960s, Fama (1970) believed that market is very efficient despite there are some trivial contradicted tests. Until recently, both empirical and theatrical efficient market hypothesis was being disputed by behavior finance economist. They have found that investor have psychological biases and found evidences that some stocks outperform other stocks. Moreover, there are evidences prove that market are not efficient for instance financial crisis, stock market bubble, and some investor can earn abnormal return which happening regularly in stock markets all over the world. Therefore, the purpose of this essay is to demonstrate that Efficient Market Hypothesis in stock (capital) markets does not exist in the real world by proofing four outstanding unrealistic conditions that make market efficient: information is widely available and cost-free, investor are rational, independent and unbiased, There is no liquidity problem in stock market, and finally stock prices has no pattern.

Most of Hayek’s work from the 1920s through the 1930s was in the Austrian theory of business cycles and capital and monetary theory. Hayek saw, that the price system did a remarkable job of co-coordinating people's actions, even though that co-ordination was not part of anyone’s intent. Hayek believed that the market was unplanned and was not designed by anyone. However, it did evolve slowly as a result of human actions. Nevertheless, no market works perfectly causing booms and busts throughout the market.

Last but not least important, an efficient capital market is one in which stock prices fully reflect all available information. However, the paradox is that since information is reflected in security prices quickly, knowing information when it is released does an investor little good. Furthermore, it is impossible to create a portfolio which would earn extraordinary risk adjusted return. As a consequence, all the technical and fundamental analysis are useless, no one can consistently outperform the market, and new

Efficient-market hypothesis also states that it is impossible for investors to consistently out-perform the average market returns, or in other words, “beat the market”, because the market price is generally equal to or close to the fair value (Fama, 1965). It is impossible, therefore, for investors to earn higher returns through purchasing undervalued stocks. Investors can only increase their profits by trading riskier stocks (http://www.investopedia.com/). However, empirically speaking, there is a large quantity of real financial examples to support that stocks are not always traded at their fair value. On Monday October 19, 1987, the financial markets around the world fell by over 20%, shedding a huge value in a single day (Ahsan, 2012). It serves as example that market price can diverge significantly from its fair value. In addition, Warren Buffett has

Malkiel finds some evidence of “hot hands” and “cold hands,” but concludes that the evidence provides no reason to abandon the theory of capital-market efficiency. Another excellent book by Malkiel, A Random Walk down Wall Street (New York: W.W. Norton & Co., 2003), surveys the evidence for an efficient market in prose accessible to the novice.

The random walk theory is a financial theory asserting that stock market prices change randomly and no one can predict their trends of patterns (Brealey et al., 2012). Bachelier first proposed the concept of the random walk theory in 1900 (Fama, 1970). However, it is well-known by Kendall in 1953 (Brealey et al., 2012). The Efficient Markets Hypothesis was developed by Fama in 1970 (Fama, 1970). In his paper, he defined

Efficient market hypothesis proposed by Fama (1965) suggested that all relevant information is immediately incorporated into current stock prices. Moreover, stock prices change when new information come. Since new information is unpredictable, EMH implies that stock prices follow a random walk.