Examples Of Efficient Market Hypothesis

Literature Review The Efficient Market Hypothesis

The efficient market hypothesis or EMH is one of the fundamental theories of traditional finance. Two economists, Paul A. Samuelson and Eugene F. Fama, independently developed the efficient market hypothesis in modern financial times, but the phenomenon behind the efficient market hypothesis goes as far back as 1565, with evidence of random walks in the market. The efficient market hypothesis simply states that markets are rational in nature, so all available information is fully reflected on the prices of market securities as it follows the random walk model, which implies that the distribution of portfolio returns are time-invariant (Keim, 1983).

Eugene

The Three Forms of Efficient Market Hypothesis

There are three types of efficient market forms. The weak, semi strong and strong forms.

The weak form of the market efficiency holds true to the hypothesis of the random walk, which states that stock prices randomly move and any changes in the price are independent of each other. If the weak market efficiency form holds true, investors can make no predictions for the future based on past information. Thus, investors can’t beat the market by earning abnormal returns.

The weak form efficient market is the least rigorous level of market strengths. It confines itself to only one subset of public information, which is the historical share price information. In the weak form efficient market, by definition new information must be irrelevant to the previous information available, thus as the share price moves in reaction to the new information received, there are no predictions from the previous price movements and characteristics of a random walk is developed in the price movement. For the semi strong form of market efficiency, the current prices of market securities area are based on all available public information and past

It is however important to note that the January effect is not based on the rational behavior of all market participants. For example, Richard Roll, (1983) pointed out that even if some investors were motivated by taxes to trade in this manner, there are other investors who could buy in anticipation of the excess returns expected in January. But this fails to be the case because the January effect continues. Other reasons to explain the January effect asides from the tax loss hypothesis include window dressing, information release, and the bid-ask