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    Efficient Market Hypothesis

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    Vishnu Prasanna
    The document discusses the random walk hypothesis and efficient market hypothesis. It explains that under the random walk hypothesis, stock price changes are random and unpredictable. It also describes the three forms of market efficiency as weak, semi-strong, and strong form efficiency based on what information is reflected in security prices. Empirical evidence for both the random walk hypothesis and efficient market hypothesis is also discussed.

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    Efficient Market Hypothesis

    Uploaded by

    Vishnu Prasanna
    16 views12 pages
    The document discusses the random walk hypothesis and efficient market hypothesis. It explains that under the random walk hypothesis, stock price changes are random and unpredictable. It also describes the three forms of market efficiency as weak, semi-strong, and strong form efficiency based on what information is reflected in security prices. Empirical evidence for both the random walk hypothesis and efficient market hypothesis is also discussed.

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    The document discusses the random walk hypothesis and efficient market hypothesis. It explains that under the random walk hypothesis, stock price changes are random and unpredictable. It also describes the three forms of market efficiency as weak, semi-strong, and strong form efficiency based on what information is reflected in security prices. Empirical evidence for both the random walk hypothesis and efficient market hypothesis is also discussed.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    16 views12 pages

    Efficient Market Hypothesis

    Uploaded by

    Vishnu Prasanna
    The document discusses the random walk hypothesis and efficient market hypothesis. It explains that under the random walk hypothesis, stock price changes are random and unpredictable. It also describes the three forms of market efficiency as weak, semi-strong, and strong form efficiency based on what information is reflected in security prices. Empirical evidence for both the random walk hypothesis and efficient market hypothesis is also discussed.

    Copyright:

    © All Rights Reserved
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    Download as pptx, pdf, or txt
    of 12

    Efficient Market Hypothesis

    RANDOM WALK HYPOTHESIS


    • The theory that stock price changes have the same distribution
    and are independent of each other, so the past movement or
    trend of a stock price or market cannot be used to predict its
    future movement.
    • In short, random walk says that stocks take a random and
    unpredictable path.
    • Under the random walk theory, there is an equal chance that a
    stock's price will either rise or fall from current levels.
    RANDOM WALK HYPOTHESIS
    • While EMT suggests that stock is always efficiently priced this
    theory suggests that price behaviour is never based on
    anything predictable, but is completely random.
    • The random walk theory is the belief that price behaviour
    cannot be predicted because it does not act on any predictive
    fundamental or technical indicators.
    RANDOM WALK HYPOTHESIS
    • Random walk hypothesis, 1st espoused by French
    mathematician Louis Bachelier in 1900, which states that stock
    prices are random, like the steps taken by a drunk, and
    therefore are unpredictable.
    • A few studies appeared in the 1930’s, but the random walk
    hypothesis was studied and debated intensively in the 1960’s
    RANDOM WALK HYPOTHESIS
    • Chartists and technical theorists believe historical patterns can
    be used to project future prices. While the random walk
    hypothesis claims that such movements cannot be accurately
    predicted.
    RANDOM WALK HYPOTHESIS
    • Information is freely and instantaneously available
    • Keen competition among market participants
    • Prices change only in response to new information
    • Since new information cannot be predicted in advance, price changes
    too cannot be forecast.
    EFFICIENT MARKET HYPOTHESIS
    Market efficiency is defined in relation to information that is reflected in
    security prices.

    • Weak-form efficiency Prices reflect all information found in the record


    of past prices and volumes.
    • Semi-strong form efficiency Prices reflect not only all information found
    in the record of past prices and volumes but also all other publicly
    available information.
    • Strong-form efficiency Prices reflect all available information, public as
    well as private.
    Relation of 3 Forms of EMH

    Strong

    Weak
    Past Market All Public All Public &
    Info Info Private
    Info

    Semi-
    Strong
    Three Forms Of Market Efficiency
    Form Definition Example

    Weak Financial asset (stock) prices Nothing of value is to be


    incorporate all historical gained by analyzing past stock
    Form information into current prices; price changes, since this
    future stock prices cannot be doesn’t help you predict future
    predicted based on an analysis price changes. Renders
    of past stock prices. “technical analysis” useless.

    Semi- Stock prices incorporate all The relevant information in an


    strong publicly available information SEC filing will be
    Form (historical and current); there will incorporated into a stock
    not be a delayed response to price as soon as the filing is
    information disclosures. made public.
    Strong Stock prices incorporate all
    Form information--private as well as Stock prices will react to a
    public; prices will react as soon dividend increase as soon as
    as new information is generated, the firm’s board of directors
    rather than as soon as it is votes--and before the board
    publicly disclosed. announces its decision
    publicly.
    Misconceptions about the Efficient Market
    Hypothesis
    • The efficient market hypothesis implies that the market has perfect
    forecasting abilities.
    • As prices tend to fluctuate, they would not reflect fair value.
    • Inability of institutional portfolio managers to achieve superior
    investment performance implies that they lack competence.
    • The random movement of stock prices suggests that the stock market
    is irrational.
    EMPIRICAL EVIDENCE
    Empirical Evidence on Weak-form Efficient Market Hypothesis
    Returns over Short Horizons
    • Serial Correlation Tests
    • Runs Tests
    ++-+++
    • Filter Rules Test
    Returns over Long Horizons
    • "fads hypothesis"
    Empirical Evidence on Semi-strong Form
    Efficient Market
    • Event study
    • Portfolio Study

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