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Efficient Market Hypothesis Essay

947 words - 4 pages

For a market to be considered efficient it means that at any given time market prices will fully reflect all available information. If this holds true, it means that it would be impossible for investors to beat the market, as securities would always trade at their fair value making fundamental and technical analysis ineffective. Investors would only be able to obtain normal rates of return in an efficient market. This idea is captured in the Efficient Market Hypothesis (EMH) that was thought up by Eugene Farma in his Ph.D. dissertation in the 1960s. As part of the EMH there are three possible levels of efficiency. These include weak, semi-strong, and strong form. In the weak form of market ...view middle of the document...

This evidence refutes the idea of strong form efficiency because if someone with inside (private) information can make abnormal returns than it can be concluded that all private information is not reflected in a securities current price.
A good example to refer to when considering the semi-strong form of market efficiency is the returns of mutual funds. Mutual fund managers rely heavily on public information, along with analysis, so if the market is in semi-strong efficiency then mutual funds should have returns that are the same (no higher than) the market. To compare mutual funds to the market as a whole we can use a Standard and Poor’s 500 Index Fund to reflect the market as a whole. Looking at the research of Lubos Pastor and Robert Stambaugh in their paper Mutual Fund Performance and Seemingly Unrelated Assets for the Journal of Financial Economics in 2002 they found that between 1963 and 1998 mutual funds on average had a return of 2.13% less than the market. There are various other studies that also support the fact that mutual funds on average do not beat broad market indexes. With this knowledge an investor can conclude that the market is in semi-strong efficiency because mutual funds managers using public information cannot beat the market because all the public information is already built into the securities current price.
When looking at weak form efficiency it is important to understand that it is assuming, because all past prices/information are already built into the current security price, that the future return will be completely independent of historical data. This means that technical analysis using past information would be completely useless to predict future prices. Most economists believe that the market is at least in the weak form of efficiency.
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