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EFFICIENT MARKET HYPOTHESIS - Essay Example

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Title: Efficient Market Hypothesis Date: ‘The Efficient Market Hypothesis (EMH) continues to provide a convincing explanation of how asset prices should respond to different types of information, but it does not provide a very a good account of the pricing of a firm’s debt and equity…
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EFFICIENT MARKET HYPOTHESIS
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Download file to see previous pages This proposition states that the markets price of securities such as shares traded in any stock exchange will vary or fluctuate according to the nature of information available to the members of the public. For instance information on company profitability, mergers, acquisition and business combination, dividend declaration and investment project that a firm intends to undertake are some of the information that influence the market price of securities. In addition to definition delineated above, efficient market hypothesis can also be delineated into three different ways, that is, allocative efficiency, operational and information efficiency. Allocative efficiency A market is considered to allocative efficient if it channels its direct savings towards the most efficient prolific project. In this case, if an enterprise is efficient it will find it easier to raise funds and this results to foster of the economy arising from the efficiency (Ogilvie, 2006). Allocative efficiency is perceived to be at its optimal if savings cannot be a channelled to an enterprise or project that would result to higher economic prosperity. . In order, to achieve allocative efficiency in the financial market , the market should contain a fewer number of financial intermediaries such that funds are allocated directly from savers to users. Operational Efficiency Operational efficiency can be simply delineated in general as the minimization of transaction cost. This efficiency concept relates to the cost of conducting business, or the cost of capital that is the interest cost charged by the lender on money borrowed to the borrower. If the transaction cost is high this usually translates to high cost of using the financial markets. (Elton 2010). Therefore, transaction should always be at its minimum in order to increase operational efficiency especially where there is fair completion between the various market players. In order to increase operational efficiency then there is need to increase the number of market players who can be able to participate in the market continuously (Elton 2010). . Information Efficiency Information efficiency relates to extent that the information available to the members of public regarding the future panorama of a security is reflected in the present price of the said security. If all parties have the same information which is reflected in the present price of the security at their disposal then conducting investigation on securities becomes fair to all parties. This levels the playing ground for all market participants, because all the parties have access to same information which also reflected by the security price. Information efficiency is of great significant to financial managers since it indicates the effect of management decision will quickly and accurately be reflected in security prices (Elton 2010). The concept of Efficient market hypothesis is main based on information processing efficiency. It articulates that stock markets are proficient if and only if is reflected in security prices accurately and rapidly(Elton 2010). Efficient Market Hypothesis Levels Efficiency Efficient Market Hypothesis efficiency can be divided into 3 different levels: Weak form level of efficiency Weak for level of efficiency indicate that the historical price of securities can be used to articulate the changes in the security prices. According to this level of efficien ...Download file to see next pagesRead More
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