Financial And Monetary Economics Essay

2364 words - 9 pages

Financial and Monetary Economics

‘‘Should we consider the Stock Market an efficient market.’’

In theory the Stock Market is said to be efficient as stock prices
should follow a random walk, which, means that stock price changes
should be random and unpredictable, If stock prices were predictable
then this would prove that the stock market is inefficient as this
implies that all available information was not already impounded in
stock prices. Hence the notion that stock prices reflect all available
information is known as the efficient market hypothesis (EMH). It was
Professor Eugene Fama who created the term EMH, in his paper
‘Efficient Capital Markets’ and claimed that in efficient markets
prices reflect all available information. There are three versions of
the EMH, and each of these versions has a different implication for
investment management.

The weak form of the EMT: Suggests that all past market prices and
data are fully reflected in asset prices. The implication of this is
that technical analysis cannot be used. Technical analysis is the
search for recurring and predictable patterns in stock prices, it also
assumes that stock prices responds slowly to demand and supply
factors, which, gives an opportunity for investors to make profit.
This analysis is against the EMH.

The semi – strong form of the EMH: Suggests that all publicly
available information is full reflected in asset prices. This implies
that neither technical analysis nor fundamental analysis can be used.
The EMH predicts that fundamental analysis would be useless because
there are many investment firms competing against each other, and it
is will be very difficult to uncover any new information that has not
been uncovered by your rival. Thus an analyst's evaluation of a firms'
prospect is would not be more or less accurate than anthers, as they
will have access to similar if not same information.

The strong form of the EMH: Suggests that all information (public and
private) is fully reflected in asset prices. This means that not even
insider information can be used to beat the market. Therefore the only
way to beat the market is by luck and chance only.

It can be noted that all three versions of EMH indicate a role for
passive management and no role for active management. As competition
makes sure that any new information is reflected in stock prices.
Supporters of the EMH believe that active management is a wasted
effort and that the expenses are unjustifiable.

“Fama disputed that in an active market of large numbers of
well-informed and intelligent investors, stocks will be appropriately
priced and reflect all available information. In these circumstances,
no information or analysis can be expected to result in out
performance of an appropriate benchmark. Because of the wide

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