Efficient Market Hypothesis Essay

Efficiency of financial markets is one of the fundamental issues in finance. The central idea of market efficiency is that market prices of securities represent true value of securities. All relevant information is immediately reflected in the prices causing abnormal profit making impossible in the market. The efficient market hypothesis further implies that prices will move randomly that makes prediction of prices extremely difficult. Efficient market hypothesis requires that investors will be rational and have homogenous expectation. Although, efficient market hypothesis came into light after the seminal work of Fama in 1965, Louis Bachelier, a French mathematician, should be considered as the pioneer of the conceptual development of efficient

Frederick MacCauley documented that fluctuations of the stock market is analogous to the chance curve that could be obtained by throwing a dice (MacCauley, 1925). Oliver (1926) and Mills (1927) provided evidence that the distribution of stock returns is leptokurtic in nature. Random movement and inability to predict stocks prices is found in a number of studies during 1920s and 1930s. Cowles (1933) analyzed stock price prediction made by the 45 representatives of financial agencies during 1928 to 1932 and found that forecasters cannot forecast movement of stock markets. Working (1934) mentioned that stock return behaved like a number in the lottery. Several studies in the 1950s documented features of stock market that resembles those of an efficient market. Friedman (1953) found that efficient market can exit in a situation where trading strategies of investors are correlated, due to the existence of arbitrage. Kendall (1953), analyzing 22 weekly price series, found that stock prices movement at a close interval moved randomly. He mentioned that prices behaved like wondering series and showed very low serial correlation. Since individual stock price was not found differ significantly with the average, prediction of stock prices even a week ahead became very difficult. Roberts (1959) also documented that stock price movement follows random walk hypothesis. Osborne (1959) proved the evidence of random movement of stock prices by showing that logarithm of stock prices follow the probability distribution of a particle in Brownian