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What is Efficient Market Hypothesis? Understand the Basic Concepts!

by May 11, 2018Homework Answers

Efficient Market Hypothesis Homework Answers

Efficient Market Hypothesis (EMH) is a theory in financial economics developed partially by Eugene Farma in 1960s. Students of economics definitely know or at least have heard of this theory. Efficient market hypothesis homework answers are something they usually search for.
Essentially, this theory states that all information available is reflected by market prices. Therefore, it is impossible for the investors to ‘beat the market. There are different variations, primary one being the idea that market prices account for all the publicly available information.
What does EMH suggest?
By this theory, share prices change only for reflecting new information as they become available. Thus, if new information becomes available about a company, the price changes quickly for reflecting that.
The underlying argument of EMH is that beating the market is not a possibility since market can neither be inflated nor undervalued. Instead, it’s efficient. All information and knowledge that is publicly available is incorporated by the price of a share of the company, which are at a correct and fair level.
Therefore, whether the share you buy will go up or not in it is dependent on future information, which is unknown. Anything that might have happened to price in past will not play any role on its future movement. The present price already accounts for all the things that might affect its future movements.
Speaking from an academic point of view, students studying economics should have knowledge about this theory. Of everything else, you would require the knowledge for completing your homework and assignments. Of course, you can opt to get online help for efficient market hypothesis homework answers. These unique online services can help you a great deal, especially if you are struggling with your homework.
Assumptions behind efficient market hypothesis

  • Several buyers and sellers
  • Perfect information about the profit of firms and market trends
  • The expectations of agents are rational
  • On an average basis, the agents make good decisions on buying of stocks or shares

Efficient Market Hypothesis Implications

  • Markets efficiently determine the prices of financial securities
  • Investors have a tendency of being rational
  • Unless you are lucky, outperforming the market is not possible
  • The future stock performance might not be determined by the prices. For instance, the market might not have any idea about an event which would result in lower profit
  • Buying and Selling is easy.

Meeting the criteria in real world
On paper, this seems to be a very sensible theory. In fact, it might be all you need for writing your efficient market hypothesis homework answers. However, you must also know that some criteria have to be met for this hypothesis to work. Firstly, all the relevant information should be immediately and fully accessible within the market. Also, all the participants of the market should act rationally. Both these conditions are difficult to ensure in reality, if not completely impossible.
Three types of EMH
Three distinctive levels or strengths were identified by Farma at which a market might really be efficient:

  • Weak EMH
  • Semi-strong EMH
  • Strong EMH

Strong form of EMH
As per Efficient Market Hypothesis, in its strongest form, a market is considered to be efficient if all the information that holds relevance to a share’s value, whether or not usually available to potential or existing investors, is reflected accurately and quickly in the market price.
For example, if a certain piece of privately held information justifies a value that is higher than present market information, this anomaly in pricing would be exploited by those who hold the information.
They will do so by buying shares until the excess demand of shares drives the price to the level that their private information supports. They will not have any incentive for buying at this point. As a result, they shall withdraw from market, and at this level of equilibrium, the price will stabilize.
This is known as the strong form of Efficient Market Hypothesis. In the theoretical sense, it is the most compelling and satisfying form of EMH. If you have homework on the types of EMH, you would have to include details about this form in your efficient market hypothesis homework answers.
Semi-strong-form of EMH
According to Efficient Market Hypothesis, in a relatively less strong form, a market is considered to be efficient if the market price quickly reflects all the relevant information that is available publicly. This is known as semi-strong form of EMH.
While the strong form might be quite compelling, it is the semi-string form that is probably most appealing to the common sense. According to it, if new relevant information is published, the market will digest it quickly by moving price another equilibrium level.
This level is reflective of the change in demand and supply caused by that information emerging. It might not be intellectually rigorous, but the semi-strong EMH is certain empirically strong because testing it is less difficult in comparison to the strong form.
There is a problem with semi-strong form. It is identifying the relevant information that is publicly available. In reality, things are not as clear-cut. This is because information does not state which shares it affects and which it doesn’t.
Weak form of EMH
Lastly, the weak form of EMH is confined to only a single subset of public information- the historical information about the share price. By definition, ‘new’ information shouldn’t be related to the previous information. It wouldn’t actually be new otherwise.
Any movement in the price of a share in response to newly available information cannot be predicted from the previous price or movement. Price develops on a random basis. To put it in simpler words, a study of historic prices does not predict the future price.
The forms of EMH and excess returns
Each of these three forms is important for your efficient market hypothesis homework answers. In context of excess returns, i.e., returns excessing what is justifiable by the incurred risks for holding certain investments, the three forms have different consequences.
Correlation between successive prices does not exist in a weak-form efficient market. Thus, study of past price movements doesn’t not allow you to consistently achieve excess returns. Such kind of study is known as chart or technical analysis, since it is based on past price patters, with no regards to more background information.
In a semi-strong efficient market, the best available and unbiased predictor of fair price is the present market price. It has regarded all the information that is available about the return and risk of an investment. Excess returns cannot be consistently yielded studying public information.
This conclusion is controversial as it suggests that fundamental analysis of sectors, economy, and companies cannot produce higher returns on a consistent basis. With such a finding, the relevance of investment research and analysis is called into question.
In a strong-form efficient market, the present market price serves as an unbiased and best available predictor of fair price. It has regard to all the relevant information, regardless if the information is public or not. Thus, as we mentioned earlier, even inside information trading cannot yield excess returns on a consistent basis. Such a reasoning might sound attractive in theory, but in practice testing, it is impossible with any academic rigor.