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The Efficient Market Hypothesis - Essay Example

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There has been significant interest on the part of scholars and academicians as to the causes behind movement of stock prices and their predictability. The Efficient Market Hypothesis suggests that stock prices tend to move because of available information…
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The Efficient Market Hypothesis
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Download file to see previous pages In this way, only information bears the power to move market prices.
There happens to be three levels of market efficiency as delineated by Fama (1970) viz. weak, semi-strong and strong. According to Fama (1970), weak form of market efficiency that market prices are affected by a stock's past performance and previous returns. The semi strong form of market efficiency suggests that market prices reflect all the available information. This degree of market efficiency exists when there are no under or over valued securities in the market and when new information affects market prices very rapidly. The strong form of market efficiency elaborates that all types of information, whether public or private, affects market price of securities. Despite the importance of the Efficient Market Hypothesis, its validity is highly debatable in the literature which is discussed in this essay.
According to the Efficient Market Hypothesis, stock prices move in negative and positive directions while responding to information and announcement of events. However, there has been staunch concern owing to market anomalies that indicate deviations from Efficient Market Hypothesis such as Holiday effect [e.g. Ariel (1990)], Monday effect [e.g. French (1980)], November effect [e.g. Bhabra, Dhillon and Ramirez (1999)], January effect [e.g. Bhardwaj and Brooks (1992)] and P/E ratio effect [e.g. Basu (1977)]. Critics are also of the view that movements in stock prices also reflect psychological factors and irrationality on the part of investors [e.g. La Porta, Lakonishok, Shliefer, and Vishny (1997), Shleifer and Summers (1990) etc.]. There has also been significant evidence that economic conditions great affect stock returns [e.g. Schwert (1989)]. The following paragraphs examine the Efficient ...Download file to see next pagesRead More
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