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Importance Of Emh In The Valuation And Investment Internet Related Stock Market

2980 words - 12 pages

1.0Introduction1.1PurposeThe purpose of this report is to investigate the Internet-related stock market, and the importance of EMH in its valuation and investment.1.2ScopeVarious textbooks on finance and certain web-sites were used to gather information and discuss the issues.1.3LimitationsThe limited word count of this report is a big limitation as a number of other important issues could not be covered and the current issues stated could be in a more detail form.1.4BackgroundEfficient market hypothesis (EMH) states that the price of a security accurately reflects the information. Various different types of information are relevant to pricing an asset, including, in the case of shares, decisions made by the management of the company. As information is what is important in the pricing of a share, the theory of EMH is important in share valuation.There has been mixing evidence of EMH. Developed capital markets are usually semi-strong form and developing ones are of weak-form. From past evidence it can be seen that they both produce market anomalies. These are discussed later.The size and potential of the Internet-related stock market is so huge. Some of these stocks that have had stock prices going through the roof. Most of these stocks had been highly overvalued, until the point at which the market had realised and since then the market has been adjusting the prices.The implication of EMH to Internet stocks is very important to investors and corporate management, as it is the information that is being used to price the stocks.2.0EMH Theoretical framework2.1Definition of Fama (1970, 1991)In an efficient market the prices of securities 'fully reflect' all available information."Fama presented the efficient market theory in terms of a fair game model, contending that investors can be confident that a current market price fully reflects all available information about a security and the expected return based upon this price is consistent with its risk." (Reilly & Norton, 1999)Information is related to price. Hence prices of securities would change as and when new information becomes available in the market. So prices will move only with the arrival of new information.When new information arrives in the market a large number of participants analyse the information and value the securities accordingly. Participants will analyse all available information in the market and will take advantage of any available profit making opportunities.This hypothesis implies that investors have rational expectations, profit-maximising price-takers and they cannot earn abnormal gains by using the available information.2.2Classification of market efficiencyFama (1970) originally proposed a three-way classification of market efficiency based directly on information:1.Weak form efficiency: information contained in the past series of prices of a security is reflected in the security's current market price.2.Semi-strong form efficiency: all publicly available information...

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