efficient markets hypothesis

Examples of efficient markets hypothesis in the following topics:

• Behavior of an Efficient Market

  • Efficient-market hypothesis (EMH) asserts that financial markets are informationally efficient and should therefore move unpredictably.
  • In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient. " As a result, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.
  • In response, proponents of the hypothesis have stated that market efficiency does not mean having no uncertainty about the future.
  • The efficient-market hypothesis emerged as a prominent theory in the mid-1960's.
  • In 1965 Eugene Fama published his dissertation arguing for the random walk hypothesis, and Samuelson published a proof for a version of the efficient-market hypothesis.

• The Efficient Market Hypothesis

  • The EMH asserts that financial markets are informationally efficient with different implications in weak, semi-strong, and strong form.
  • The efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient. " In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.
  • There are three major versions of the hypothesis: weak, semi-strong, and strong.
  • To test for strong-form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time.
  • Even if some money managers are consistently observed to beat the market, no refutation even of strong-form efficiency follows–with hundreds of thousands of fund managers worldwide, even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers.

• Limitations of Financial Statement Analysis

  • Financial statement analyses can yield a limited view of a company because of accounting, market, and management related limitations of such analyses.
  • Ratio analysis using financial statements includes accounting, stock market, and management related limitations.
  • The efficient-market hypothesis (EMH), for example, asserts that financial markets are "informationally efficient. " In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.
  • While the weak form of this hypothesis argues that there can be a long run benefit to information derived from fundamental analysis, stronger forms argue that fundamental analysis like ratio analysis will not allow for greater financial returns.
  • These audiences also see limits to ratio analysis as a predictor of stock market returns.

• Implications and Limitations of the Efficient Market Hypothesis

  • Investors and researchers have disputed the Efficient Market Hypothesis both empirically and theoretically.
  • Empirical evidence has been mixed, but has generally not supported strong forms of the Efficient Market Hypothesis.
  • Rational investors have difficulty profiting by shorting irrational bubbles because, as John Maynard Keynes commented, "markets can remain irrational far longer than you or I can remain solvent. " Sudden market crashes, like the one that occurred on Black Monday in 1987, are mysterious from the perspective of efficient markets, but allowed as a rare statistical event under the Weak-form of EMH.
  • Any test of this proposition faces the joint hypothesis problem, where it is impossible to ever test for market efficiency, since to do so requires the use of a measuring stick against which abnormal returns are compared-- in other words, one cannot know if the market is efficient if one does not know if a model correctly stipulates the required rate of return.
  • Market strategist Jeremy Grantham has stated flatly that the EMH is responsible for the current financial crisis, claiming that belief in the hypothesis caused financial leaders to have a "chronic underestimation of the dangers of asset bubbles breaking. " Noted financial journalist Roger Lowenstein blasted the theory, declaring "the upside of the current Great Recession is that it could drive a stake through the heart of the academic nostrum known as the Efficient-Market Hypothesis. " Former Federal Reserve chairman Paul Volcker chimed in, saying, "[it is] clear that among the causes of the recent financial crisis was an unjustified faith in rational expectations and market efficiencies. "

• Formulating the Hypothesis

  • A hypothesis is a potential answer to your research question; the research process helps you determine if your hypothesis is true.
  • One of his hypotheses was that regions with strong traditions of civic engagement would have more responsive, more democratic, and more efficient governments, regardless of the institutional form that government took.
  • This is an example of a causal hypothesis.
  • To test this hypothesis, he compared twenty different regional Italian governments.
  • While there is no single way to develop a hypothesis, a useful hypothesis will use deductive reasoning to make predictions that can be experimentally assessed.

• Testing a Single Proportion

  • Here we will evaluate an example of hypothesis testing for a single proportion.
  • Cell Phone Market Research Company conducted a national survey in 2010 and found the 30% of households in the United States owned at least three cell phones.
  • Null Hypothesis in words: The null hypothesis is that the true population proportion of households that own at least three cell phones is equal to 30%.
  • The conditions are satisfied, so we will use a hypothesis test for a single proportion to test the null hypothesis.
  • We do not have strong evidence against the null hypothesis.

• Markets are Typically Efficient

  • A perfectly competitive market with full property rights is typically efficient.
  • An efficient market maximizes total consumer and producer surplus; there is no deadweight loss .
  • Economists refer to two types of market efficiency.
  • A market has allocative efficiency if the price of a product that the market is supplying is equal to the value consumers place on it.
  • A market can be perfectly efficient but highly unequal, for example.

• Allocative Efficiency

  • Free markets iterate towards higher levels of allocative efficiency, aligning the marginal cost of production with the marginal benefit for consumers.
  • Optimal efficiency is higher in free markets, though reality always has some limitations and imperfections to detract from completely perfect allocative efficiency.
  • Markets are not efficient if it is subject to:
  • Allocative efficiency is the main means to measure the degree markets and public policy improve or harm society or other specific subgroups.
  • For example, for the U.S. to achieve an allocative efficient market, it would need to produce a lot of coffee.

• Thinking about Efficiency

  • An efficient market maximizes total consumer and producer surplus.
  • Not all markets are efficient.
  • Economists often seek to maximize efficiency, but it is important to contextualize such aims.
  • Most commonly, efficiency is contrasted or paired with morality, particularly liberty, and justice.
  • For example, taxation will always cause some inefficiency in markets, but many individuals believe that the benefits of programs such as Social Security and public schooling are worth the loss in efficiency.

• Productive Efficiency

  • An equilibrium may be productively efficient without being allocatively efficient.
  • In other words, just because a market maximizes the output it generates, that doesn't mean that social welfare is maximized.
  • In long-run equilibrium for perfectly competitive markets, productive efficiency occurs at the base of the average total cost curve, or where marginal cost equals average total cost.
  • So, consumers may pay less with a monopoly, but a monopolistic market would not achieve productive efficiency.
  • Points B, C, and D are productively efficient and point A is not.