Based on recent events, discuss whether the stock markets are efficient according to the EMH - Essay Example

Whether the market is efficient or not remains a debatable topic among the stock market investors. Secondly, according to this hypothesis, a single investor is never able to get higher profitability than another investor by investing the same amount of fund. Lastly, EMH asserts that no investor would be able to surpass the average annual returns that all the funds and investors are able to achieve cumulatively. Discussion A competitive information market would allow private gains from producing private information, and tests of competition would require estimates of the cost of private information production.

According to the efficient market hypothesis, stock market participants tend to form rational expectations of the future in the aggregate by comprehending all the information available in the market. Assuming the stock market efficiently discounts the rational expectations of investors, the prices of stocks accurately reflect an assessment of the intrinsic value based upon the relevant information available (Gorda, 2005, p. 234). Thus, only the unexpected new information is likely to affect a movement in stock prices.

A close look at stock prices sometimes reveals day-of-the-week effects wherein stock prices tend to rise on Mondays and fall on Fridays; time-of-the-year effects wherein stock prices tend to rise in January; and small firm effects wherein the prices of small firms’ stocks may rise by a more difference than those of large companies. But there is no evidence that an average market investor can follow these effects to earn super normal profits after the transaction costs are considered (Forbes, 2013).

According to Fama (1970, p. 72), an efficient market is one in which the prices are always reflective of the information available, and the sufficient conditions for a market to be efficient are: the information is available without cost to all the market participants; there are no transaction costs involved in trading of securities; and all market participants agree on the implications of the current information. In practice, the information generated in the market has a significant effect on the stock prices of related companies.

For example, after Microsoft announced that it would acquire Nokia, the share prices of Nokia almost doubled, increasing its value to about 22 billion Euros. Also, as a series of lawsuits occurred between Apple Inc. and Samsung Electronics over the design of smartphones and tablets, the share prices of both companies declined in the stock market. The stock market has been inefficient in recent times because of the substantial frictions that the market has been experiencing (Beechey, 2000, p. 57).

Efficient market is not likely to exist even when there is complete absence of frictions and irrationality in the market. The central bank plays an appropriate role in the intervention in the financial markets with the objective of stabilising the asset prices. The market shows patterns of inefficiency due to the financial instability majorly driven by human myopia and imperfect rationality. The market does not show such quick adjustment to the receipt of new information as is stated in the efficient market hypothesis.

The market is not efficient considering that the stocks with lower price to earnings ratios have higher risk adjusted returns than the stocks with higher price