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Efficient Market Hypothesis in Explaining the Overall Functioning of the Financial Markets - Essay Example

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The paper "Efficient Market Hypothesis in Explaining the Overall Functioning of the Financial Markets"  identifies the weak, semi-strong and strong form of efficiency and implications of the data on the asset prices. The market participants form rational expectations about the future and present market prices are the best guess of the future.
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Efficient Market Hypothesis in Explaining the Overall Functioning of the Financial Markets
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Download file to see previous pages What is important to note that financial crises were largely unanticipated as they emerged due to the subprime mortgages which form a very little percentage of the overall activity that takes place in the financial markets. This, therefore, raises the question of how many investors actually mispriced the risk that has to be included in the pricing of the securities given the fact that market participants always form rational expectations about the future equilibrium prices. Rational Expectations theory forms the basis of some of the most important macroeconomic models in recent times. The formation of the efficient market hypothesis is also one of the macroeconomic models which utilize the rational expectations theory and asserts that market participants always form rational expectations about the future equilibrium prices. Thus it is useless in predicting future financial crises as the market participants already discount such future information into their risk calculations. (Hui & Lui, 2002). However, despite such theoretical assumptions, the current global financial crises were more of a shock for most of the participants as they emerged out of blue and affected almost every market on the earth. This paper will attempt to discuss the question of predicting future financial crises in the light of efficient market hypothesis and rational expectations and will attempt to answer the question by considering the current global financial crises. Current Global Financial Crises
The current financial crises have slowed down the pace of economic growth in many countries including the US and UK and many governments have to inject money in order to save their financial systems from complete collapse. These financial crises apparently emerged due to the imprudent banking practices and resulting lending into the subprime mortgage sector. Over the period of time, the competition for banks became stronger and banks, thanks to deregulation, were allowed to engage themselves into practices that were relatively more speculative in nature.  ...Download file to see next pagesRead More
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