Efficient Market Hypothesis

The efficient-market hypothesis was developed

by Professor Eugene Fama at the University of
Chicago, Booth School of Business as an
academic concept of study in the early 1960s.
Empirical analyses have consistently found
problems with the efficient-market hypothesis, the
most consistent being that stocks with low price
to earnings outperform other stocks

Efficient Market Hypothesis

The efficient-market hypothesis (EMH) asserts
that financial markets are "informationally
efficient".
That is, one cannot consistently achieve returns
in excess of average market returns on a riskadjusted basis, given the information publicly
available at the time the investment is made.

Efficient Market Hypothesis

EMH states that it is impossible to beat the
market because prices already incorporate and
reflect all relevant information.

This is also a highly controversial and often

disputed theory. Supporters of this model believe
it is pointless to search for undervalued stocks
or try to predict trends in the market
through fundamental analysis or technical
analysis.

Efficient Market Hypothesis

Under the efficient market hypothesis, any time
one buys or sells securities, one is engaging in a
game of chance, not skill.
If markets are efficient and current, it means that
prices always reflect all information, so there's no
way you'll ever be able to buy a stock at a
bargain price.

Efficient Market Hypothesis

In capital markets, the security prices may reflect
the following:

All past information regarding the security &

company.
All information announced but not
implemented.
All information that is generated but not yet
made public.

EMH: Assumptions
1. The share prices of the market discount all the
available information quickly.
2. Markets are efficient i.e. the flow of information
is free & unbiased.
3. Every investor has free excess to the same
information & no one has superior knowledge.
4. The stock market is wide & supreme, no one
can influence the market.
5. The supply & demand of the shares is free &
markets can quickly adjust it.

EMH: Assumptions
6. The share prices will move in an independent
manner.
7. No individual has inside information.
8. All share price movements are a result of
rational investment decisions.
9. Institutional investors or any major fund
managers cannot influence the stock market.

Forms of Efficient Market Hypothesis

The information available to the public can be
categorized into three forms; the past prices,
other public information & inside information.
The market efficiency can be classified as
follows:
a)Weak Form (price information)
b)Semi Strong Form (other public information)
c)Strong Form (inside information)

Efficient Market Hypothesis

STRONG
FORM

SEMI
STRONG
FORM
WEAK
FORM

Efficient Market Hypothesis: Weak Form

According to the weak form of market efficiency,
the security prices reflect all past data i.e., all
historical information about the company is
already reflected in the current prices.
This theory is also known as Random Walk
Theory which states that the security prices move
as a result of inflow of news which randomly
enters the market .

Efficient Market Hypothesis: Semi

Strong Form
In the semi-strong form of market efficiency, the
current prices in the capital market not only reflect
the historical information but also all the publicly
available information.
As all public information is already reflected in the
value of a security, no one can use the
fundamental analysis to determine whether a
stock is overvalued or undervalued.

Efficient Market Hypothesis: Strong

Form
Strong form of market efficiency says that the
securities prices reflect all information whether
published or unpublished & even private inside
information.
In such a market, no investor would be able to
earn abnormal return by using any information as
the information is already reflected in the
securities prices.

Efficient Market Hypothesis:

Criticism
Securities price is always the correct one.
Perfect Markets.
Velocity of new information (freely available).
Evaluation of information.

Random Walk Theory / Hypothesis

The random character of stock market prices
was first modelled by Jules Regnault, a French
broker, in 1863 and then by Louis Bachelier, a
French mathematician.
A small number of studies indicated that US
stock prices and related financial series
followed a random walk model. Research
by Alfred Cowles in the 1930s and 1940s
suggested that professional investors were in
general unable to outperform the market.

Random Walk Theory / Hypothesis

The random walk hypothesis may be derived
from the weak-form of efficient market hypothesis
(EMH), which is based on the assumption that
market participants take full account of any
information contained in past price movements.
The random walk hypothesis is a financial
theory stating that stock market prices evolve
according to a random walk and thus the
prices of the stock market cannot be
predicted.

Random Walk Theory / Hypothesis

In short, random walk says that stocks take a
random and unpredictable path.
The chance of a stock's future price going up is
the same as it going down.
A follower of random walk believes it is
impossible to outperform the market without
assuming additional risk.

Random Walk Theory / Hypothesis

Random Walk Theory is another name for the
weak form of efficient market hypothesis.
It states that the securities prices move as a
result of inflow of news which randomly enter the
market.
Any publicly available information should already
be reflected in share prices in the market.

Random Walk Theory: Criticism

Technicians say that the random walk theory

ignore the realities of markets, in that participants
are not completely rational and that current price
moves are not independent of previous moves.

Market Efficiency &

Security Selection
LEVEL OF
APPROACH
EFFICIENCY

TECHNICAL
ANALYSIS

FUNDAMENTAL
ANALYSIS

RANDOM
SELECTION

INEFFICIENCY

BEST

POOR

POOR

WEAK-FORM
EFFICIENCY

POOR

BEST

POOR

SEMI-STRONG-FORM
EFFICIENCY

POOR

GOOD

FAIR

STRONG-FORM
EFFICIENCY

POOR

FAIR

BEST