The Form of the Efficient Market Hypothesis - Essay Example

Critically analyse the validity of the strong form of the Efficient Market Hypothesis Contents Introduction 3 Strong form 3 ment of Problems andIssues 4 Subjective Review 4 Research Problem 5 Concept of the market efficiency 6 Research hypothesis and Methodology 6 Scope and assumptions of the empirical research 7 Results of empirical research 8 Conclusions 8 References 10 Introduction The efficient market hypothesis (EMH) is categorized in three major types that are weak, semi-strong and strong. The weak EMH consists of bonds, stocks or property. It reflects all the past information that is available publicly and it claims prices on traded assets. The semi-strong EMH says that both the prices reflect publicly available information and the change that are reflected new public information. The strong EMH says that the prices are reflecting the hidden or the inside information. The critics have blamed the rational markets for the financial crisis which had in the year 2000. There was a very close relation between the EMH and the random walk hypothesis and then comes the Martingale model. The stock market price was first introduced by Jules Regnault, who was a French broker, and then followed by Louis Bachelier who was a French mathematician. Few studies indicated that US stock prices follow the random walk model. The only thing is required by the EHM is the investors reactions which is followed by a normal distribution pattern, just because the market prices should be exploited for making any abnormal profit. Thus no one can be sure about the market trend that it will be always right. The efficient market hypothesis is followed in both the ways by empirically and theoretically by investors and researchers. The imperfections in financial markets are the combination of cognitive biases and that includes overconfidence, overreaction, and other predictable human errors. In the efficient markets it has identified that the one who has a less return throughout the year is the loser and who has been getting a high return is the winner. Strong form The previous two forms of efficient market hypothesis are not only represent the market prices correctly from the past and present information but also predict the future information accurately and the random walk occurs because of some wrong predictions provided by the market about the future. Strong form is assumed that the cost of credit is in a straight line and uniform for all the investors, the transaction cost and the asymmetry information does not exist. These are not true in reality but the modern market takes it as approximation for most of the assumption part. In the substantial empirical evidence it is generally proving that in most cases of the long run many company or group can state that the prices are always fair over the long term. In the strong form of EMH, there is no point of studying the past information (Bodie, Kane and Marcus, 2008, pp.102-105). Statement of Problems and Issues In this paper researchers have tried to test the strong form of efficient market hypothesis in Indian capital market by comparing the various schemes of mutual funds with the index of NSE that indicates a benchmark. The main aim is to see whether the investors, who have invested in the capital markets like top investment companies, fund managers, security analysts, etc, are able to earn good rate of return from the index NSE (National Stock Exchange) which is a benchmark (Brealey, Myers and Allen, 2008, pp.55-58). Subjective Review The subjective review is basically the risk adjusted performance for evaluating the performance of mutual funds. The two growth oriented mutual funds are the Master Gain 1991 of UTI and the Magnum Express of SBI Mutual funds. This indicates that both the mutual fund do not perform well than the benchmark indicator that is NSE. It is also said that the Magnum Express is very highly diversified than Master gain. This study includes the CAPM methodology and all those methods which are used within the evaluation through CAPM model. This have used to calculate and to find out the difference in ranking between up and down in the market. This study tells that only the two mutual funds have outperformed the market at 95% in the significant level. It also tells about the overall performance of the fund and to find out the ability of the fund managers. The mutual funds are to earn higher return than what they have been expecting in the form of portfolios in the random. The study also tells that the mutual fund cannot beat the market, for doing the examination of the security prices for estimating the profitability will be calculated by the CAPM. It has been found that the insiders have special information but still the market is not very efficient for them. They cannot outperform the stock market though they have any private information (Brigham and Houston, 2009, pp.75-80). Research Problem The efficient and the effective operation of financial markets is basically the capital market that includes the foundations of the development of the modern economy in the markets. The stock markets play a very important role in the capital allocation and the transformation of the saving that finances the new investments which generates more wealth for the stock markets. The financial investments done in the capital markets refer to all those streams of funds that are managed by the banks and the financial institutions. They are the institutions that are in investing funds, pension’s funds and insurance companies. The stock market’s main objective is to keep an inflow of capital for entities that are issuing stocks and they are allowing them to grow wealth for the investors who are investing their capital in the stock markets. The capital market is the place where the current market values the demand and shares of the company. Stock reliability is the process of valuation that is correlated with the result that is obtained in the verification of the hypothesis stock market efficient. The most commonly asked question in the financial sectors by the prcationers and the theoretical is about the market efficiency. The strong form of efficient market implies that it is impossible to achieve profit above the average line which has been set by the stock market. The access to fundamental information, the information about the stock price and the knowledge about the non-public information do not ensure any guarantee for the development of long term investment strategy. This approval is given in the form of market efficiency when all the information about public and non-public information is reflected in the stock market prices. Concept of the market efficiency The concept of the market efficiency is one of the informational efficiency that has been used in the fundamental terms in the finance sectors. It uses relevant information that is reflected in the price of the financial assets. The concept of market efficiency was formalised in the basis of expected value which is relatively relevant information. This theory states the market stability and can also be expressed by the value that is the expected returns on the effective market (Brown and Reilly, 2008, pp.153-157). Research hypothesis and Methodology The following methodology has been aim to verify the two research hypothesis: RH I: It should have access to the information that is allows to the institution requesting for achieving the positive capital flow in the time between receiving the information in the moment of its publications. RH II: This tells to achieve the abnormal rate of return in the time that has been referred to the market index rate of return. The strong form of efficient hypothesis is measured with the help of statistical and econometric methods in the polish market to verify. The analysis of correlation and the regression methods is used for providing information on the relationship between the analysed and the random variables. The analysis of the efficient market which is the part of the polish capital market has three forms those are: X- Random variable that recommends with the values of “buy”, “neutral”, or “sell”. Y- It is a financial instrument that indicates the WIG 20 index which is the moment of receiving information and publication. Z- It indicates the return from the WIG index, which measures the possibility for receiving superior profits. Scope and assumptions of the empirical research The research on the strong efficient market hypothesis of the Warsaw Stock Exchange covers the periods between 01.01.2005 to 31.03.2010, and the reason for choosing the market analysis for the life cycle of the stock market that refer to the year 2005 as it is referred to the maturity phase of the Warsaw Stock Exchange. The entities that are covered by the research company companies that comprise the WIG 20 index when it is conducting the analysis. The recommendations that are available between 01.01.2005 and 31.03.2010 in most cases were buy and sell values. The institutions that are recommending around 63 entities and some of them are mentioned and they are: ABN AMBRO, ING, Bank of America, Barclays Bank, Deutsche Bank and etc. All the information has their date stated and the information published are known by the non-public information, 5 days from the date of announcement. More than 95% of recommended average term referred the research to be defined by the 6 months from the period when new information was published. The conducted the analysis excluding the recommendation of a neutral value because they do not favour the decision making process and that do not provide added value. Results of empirical research The variables of the recommendation are the rate of return that has been showed in many of the cases, and the analysis is done between the variables and the rate of return. In the absence of such correlation or the poor correlation is between variables and it is not statistically considerable. The estimator of correlation coefficient was different statistically from 0 to -27, 54, -93, 37 and -56, 74 respectively that are found in the cases of few companies such as Bank Zachodni WBK, Mol and Polimex-Mostostal respectively. In each of the cases the estimator sign is indicated the ability for estimating the movement of the assets price in the analysis period. The correlation analysis is conducted by the whole information set that is considering all the assets that are analysed. In such cases the estimator is amounted from -1, 57. The regression application is firstly required to verify the assumptions of Gauss-Markov methods which is least squares which is referring to the correlation of the residuals (Bodie, Kane & Marcus, 2013, pp.88-95). Conclusions In the efficient market hypothesis there are three major types of form and those are weak, semi-weak, and strong. The weak is consist of the bonds, stocks, property which reflects in the stock markets, the semi-strong indicates both the public and the non-public information that reflects in the change of new public information and the strong form of the efficient market represent the predicted future information. This is the form where the cost of credit is linear and uniform for all the investors, the EMH has faced a financial crisis in the year 2000. The main objective of the paper was to analysis the strong form of efficient market hypothesis where it has introduced the capital markets. It has described the non-public information in developing the investment strategies whether it can beat the market with the information that is being provided from the insiders. It has also described about the research hypothesis I and research hypothesis II which is said in the empirical research, the RH I indicates for rejecting the hypothesis and the RH II is rejected in some of the cases. It also supports the Warsaw Stock Exchange in the strong efficient market of the polish market. It has used the CAPM and NSE for calculating the up and down of the market. It has evaluated that the main objective of the stock markets is that to create more and more wealth for the investors who are investing in the capital markets. It is mentioned that the polish law have stopped exploiting non-public information which is confidential. In such studies the technical and the fundamental analysis does not allow to beat the market. These are replaced by the market capitalization for reducing the transaction cost and would be attractive for an alternative investment. References Bodie, Kane & Marcus. 2013. Essentials of Investments: 9th Global Edition, Chicago: McGraw-Hill. Bodie, Z., Kane, A. and A. J. Marcus. 2008. Investment : 8th Edition, Chicago: McGraw-Hill. Brealey, R. A., Myers, S. C. and F. Allen. 2008. Principles of Corporate Finance: 9th Edition, New York: McGraw-Hill. Brigham, E. F. and J. F. Houston. 2009. New York, Fundamentals of Financial Management: 12th Edition. New York: South-Western Publication. Brown, K. C. and F. K. Reilly. 2008. New York, Investment Analysis and Portfolio Management: 9th Edition, New York: South Western Publication. Read More