Efficient Market Hypothesis: An Analysis of Financial Markets

Financial Markets and Institutes
2019

Introduction
Efficient Market Hypothesis or EHM can be thought of as a financial economic theory which
analyses the prices of the stocks available in the market and thereafter provides the user with
substantial knowledge about the same stock. It is also seen from this theory that the market
cannot be dominated because the stocks can change all over and this will change the collected
data and change all the plans. This is because the market depends on the stocks available on
it. It is also to be known that the assumption shares always trade on their base price which
can be positive. The efficient market hypothesis is a market scenario where it is not easy to
derive huge profits. It is also known as Random Walk Theory. The investors and financial
managers derive huge benefits from the efficient market hypothesis as it focuses on the
alterations taking place in the security markets and the reasons behind the occurrence of the
same (Delcey, 2015). The first person to ever use the term “efficient market” was E.F Fama
who believed that the intrinsic values can be clearly seen in the presence of a competitive
market.
Discussion of Fama’s views
E.F Fama classifies efficient market hypothesis into three categories that are listed below-
• Weak Form Efficiency
Weak form efficiency signifies that the current prices prevailing in the market fully project
the information carried by the previous prices only. This indicates that it is impossible to
detect such securities that are mispriced and therefore, the chances for overruling the market
are almost negligible (Decley, 2015). In this form of market efficiency, it is impossible for
one to make full use of available information in detecting mispriced securities and beat the
market.
• The semi-strong form of Efficiency
Semi-strong form efficiency signifies that the current prices prevailing in the market reflect
all such possible information that is publicly available. The main objective behind this form
of efficiency is to disallow the others to take undue advantage of such information that
someone else is aware of. This form of efficiency has various data from the financial
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statements of the company like annual reports, dividends, merger plans, etc apart from just
previous prices (Hirshleifer, Hsu & Li, 2013).
• Strong form efficiency
Strong form efficiency signifies that the current prices reflect all the information may it be
public or private. Strong form efficiency signifies a market where predictions are made fairly
and the prices of securities reflect detailed information. It also signifies that the management
of an organization is unable to derive benefits from the insider information even if the same is
received in advance (Decley, 2015).
EMH depicts all such necessary information concerning the fundamental that is reflected
through security prices. EMH enables the investors in deriving huge benefits from employing
passive strategies and deploying the traditional ones. The hypothesis allows the assets that are
overpriced to be priced as per the risk is borne by the same (Bailey, Kumar & Ng, 2011). The
efficient market hypothesis is updated from time to time so that the actual prices prevailing in
the market are reflected. EMH depicts financing costs, agency costs, transaction costs, cost
information, etc. EMH allows the investors to understand the situations prevailing in the
market and use them accordingly so as to derive benefits. EMH is also useful for arbitrageurs
that make use of comparative advantage theory to earn profits (Bernard, 2011). The
arbitrageurs benefit from EMH because the hypothesis offers specialized knowledge, fewer
management fees and financial set up which allows them to consider such an option that has a
longer verification period. This allows the liquid markets to gain efficiency and depict a
positive picture of the same (Porter & Norton, 2014).
Investors nowadays can make use of an active management strategy, passive management
strategy or a combination of multiple approaches. A passive management strategy is
commonly known as indexing (Power, 2017). Indexed assets are invested on the basis of
specific rules that employ such an index that has multiple securities derived from giving due
consideration to the conventional performance and various risk features (Kaniel, Liu, Saar &
Titman, 2012). It is no doubt that the efficient market hypothesis always depicts that the
market price of security signifies valuable information. EMH has received a lot of critics ever
since the same got recognized.EMH allows the investors to identify the overpriced securities
which are criticized by various financial analysts and other portfolio managers (Delcey,
2015). Prices of such securities that have different participants must be adjusted as per the
new information by fair means. The theory states that an investor cannot overrule the market
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