Efficient market hypothesis
|✅ Paper Type: Free Essay||✅ Subject: Finance|
|✅ Wordcount: 3221 words||✅ Published: 1st Jan 2015|
From the last several decades the efficiency of stock market has been the sole purpose of research studies. As a result, several theories have been introduced and implemented in relation to principally how the competition in the stock market will force the known information into the prices of securities. The knowledge of information on a variety of securities that are traded in the market is one of the major factors in influencing the movements of stock market. In the stock market, a securities price tends to move rise and fall depending mainly on the availability of the information. The stock prices in the efficient market correspond to available information and therefore register any rise or fall mainly when recent and unpredictable information is available. The up and down in the security prices largely depends upon the advantages and disadvantages associated with the available information and to what extent it will affect the company’s performance which is represented by the security. As it is very difficult to tell whether the information available is useful or not, in the same way it is quite impossible to make predictions about the trend of the stock market, such that whether there will be an upward or downward trend in the near future by using the available information. In the financial market it is not mandatory that all professionals related to market always possess the information about the securities and have skills to evaluate this information for their gain. The only thing the efficient market requires is that few individuals must have the information about securities and as a result of the information supplied by them, the whole market must be well informed and benefitted. Hence the available information plays an important role in determining the efficiency of the stock market.
By focussing on the above idea, the concept of Efficient Market Hypothesis has been developed and became one of the most concentrated and debatable topic among professionals and people related to finance and stock market studies.
The main aim of my research is to analyse the efficiency of stock market supported by the concept of Efficient Market Hypothesis. It also aims to depict the impact of the Efficient Market Hypothesis on security trading by reviewing the available literature.
My research aims to answer the following questions:
- To what extent the available information, according to the concept of Efficient Market Theory, affects the security trading in stock market.
- What is insider trading and its impact on the efficiency of stock market.
- What are the various types of anomalies associated with the stock market and their effect on the stock market efficiency.
In this part of my research paper I will re-examine the existing literature on the anomalies and the efficiency of the stock market.
“An ‘efficient’ market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.”(Eugene F. Fama 1965)
If you need assistance with writing your essay, our professional essay writing service is here to help!Essay Writing Service
According to the Efficient Market Hypothesis, given by Fama, the ups and downs in the prices of securities in the financial market totally reflect known information at a specified period of time. In other words, Efficient Market Hypothesis states that the trading of securities by the individuals is always carried out purely based on the assumption that securities worth are always more or less than the price offer by market. Whereas, trading of securities trying to outperform the stock market will be luck instead of professional skills if current prices fully reflect all available information as well as stock markets are efficient. According to this hypothesis “if new information is revealed about a firm it will be incorporated into the share price rapidly and rationally, with respect to the direction of the share price movement and the size of that movement.” (Elearn’ -NetTel) . Efficiency is an unclear word in itself so for more clarification, in my dissertation, I will describe all types of efficiencies: operational, allocation and pricing. I will also give full detail on levels of market efficiency : weak-form efficiency, semi-strong form efficiency and strong-form efficiency.
According “Random walk theory “, there are no trends and format that are being followed by the prices of securities in stock market. There is another fact given by this theory which says that the prices of securities in the past can not be useful for future predictions and fluctuation in prices.
The Efficient Market Hypothesis and anomalies related to the stock market developed by the researchers always contrasts with each other. “The search for anomalies is effectively the search for systems or patterns that can be used to outperform passive and/or buy-and-hold strategies.” (Invest Home). With the invention of any anomaly, there is always a kind of exploitation by the investors of the anomalies discovered in order to increase their profit. This practice make the anomaly disappear with the passage of time. There are so many internal and external factors of the entities that affects the operations of stock market and those factors are often known as Anomalies which plays an important role in over performing or under performing the operations of the stock market by taking into consideration the fact that these anomalies have good or bad effect on the prices of stocks and entities. There are different types of anomalies and some of the anomalies are discussed.
First type of anomaly is fundamental anomaly which basically depends upon the price of the stock and on the past performance of the entity due to which stock prices rises or fall. Several anomalies of these kinds exist related to the growth, present value and profitability of the companies concerned. Under fundamental anomaly, there exist a most historical and famous anomaly named “Value investing” and is regarded as the most appropriate strategy for investment purposes. These anomalies depend on the stock value and company’s performance based on which the stock prices go up or down. A technique used is to divide the given index into high price and low price to book value stocks. The low price to book concept was developed by Eugene Fama and Keneth French favouring the hypothesis that lower risk is attached to value stocks whereas the stocks with growth are attached with higher risk. According to another anomaly named as low price to sales, stocks with low price to sales ratio perform better then high price to sales ratio. According to James P. O’ Shaughnesey, prices are the only strongest determinant of excessive return. There are several studies which advocates that stocks having low P/E ratio always perform better in the market as compared to stocks with high P/E ratios. In the same manner, the stocks with high dividend yield are better performers than stocks with low dividend yields. There are some other stocks named as neglected stock and are chosen by those with the contrarian strategy. A study was conducted by F.M DeBondtand Richard Thaler on 35 best and worst performer stocks between 1932 and 1977 in New York Stock Exchange and came out with the result that the performance of best performer stocks in the stock exchange falls whereas the stocks with bad performance in the past showed better results when compared to the results of the same stock in the past.
Another types of anomalies in which past prices and statistics are used to predict the prices of securities are known as technical anomalies. The techniques used in these types of anomalies include strategies related to support and resistance, moving averages and strength. Some researchers are against the method of technical analysis and say that the investors are hardly benefitted from these technical analysis techniques where as some researchers argue that there is enough evidence and facts that are sufficient to say that the technical analysis method is favourable for the investors. According to technical analysts, the selling of stocks is influenced by the resistance level whereas the buying is influenced at the support level. A signal to sell the stock is developed in case the support level is penetrated by the price whereas a signal to buy the stock is produced in case price penetrated the resistance level. According to the conclusion made by William Brock, Josef Lakonishok, and Blake LeBaron, the outcomes are reliable with technical rules having forecasting power. But at the same time the cost related to transaction must be taken into account before implementing such concepts and strategies. Another conclusion given by them says that the stock returns generating is more complicated and different process as compared to the results obtained by conducting different studies and researches using various linear models.
Calendar anomaly is another type of anomaly in which various effects are included. In January effect, general and small stocks perform abnormally better in the month of January. Philippe Jorion and Robert Haugen say that, “the January effect is, perhaps the best-known example of anomalous behaviour in security markets throughout the world.” An interesting fact about January effect is that it lasted for nearly two decades whereas any anomaly hardly survive as traders start taking advantage of the anomalies which results in vanishing of anomaly. Another effect named Turn of the Month was founded by Chris R. Hensel and William T. Ziemba, according to which, in between period 1928 to 1993, the returns for the turn of the month performed well and considerably greater than normal performance. According to study, those investors who make regular purchases may be benefitted if they make schedule to do the purchasing at the end and prior to the starting of next month. In addition to these effects another effect is known as Monday effect and is considered to be the worst day in stock market if investments are made on this day. According to study conducted by Lawrence Harris, the week end effect occurs during first 45 minutes of buying and selling whereas prices shows upward trend during the first 45 minutes of trading on all other days. This kind of anomaly may occur due to moods and behaviour of people after weekend holidays.
There are certain other facts that are responsible for affecting the operations of stock market. The size effect, announcement based effect, IPOs, Stock buybacks, insider transactions and S and P game.
According to Fama and French (1992), the book to market ratio as well as the size capture the cross-sectional variation of average stock returns in NYSE, and Nsdaq securities. A complete investigation of book to market was provided by Tim Loughran in relation to dimensions of firm size, exchange listings etc and experimental findings of French and Fama are basically forwarded by two features of the data which includes relatively low returns on small, new and growing stocks. Srinivas Nippani, Augustine C. Arize study three main US corporate bond market indices by taking into account calendar based anomalies between the years 1982-2002. In the analysis, the whole bond market as well as two broad classes of industries namely industrials and utilities were taken into account. The study find the mixed response for the weekend effect in the overall bond index and industrial index whereas very less response to utilities index. The findings showed definite proof of January effect on the bond market.
Our academic experts are ready and waiting to assist with any writing project you may have. From simple essay plans, through to full dissertations, you can guarantee we have a service perfectly matched to your needs.View our services
RESEARCH METHOD AND DATA:
Data Collection Methods:
The general idea of business research is that it is concerned with collection of data, making questionnaires and then analysing and evaluating the collected data. In addition to this, the identification of problem and the approach needed to solve the problem is also important. (Ghauri et al., 1995). Data sources are often referred to as the carriers of data information. Basically data sources are divided into two categories namely primary data and secondary data. Primary data is concerned with the interviews and observations collected while conducting research project where as, secondary data is collected by others and academic and non academic sources are included in this type of data.
In my topic of research which is to study the efficiency of stock market, I want to use the Desk method that is secondary data collection method. This includes the gathering of information from sources like books, journals related to my topic of research, and from electronic media like internet which is one of the major sources of information. These all sources of information will be helpful for the accomplishment of my research.
As I have already describe that I will use secondary method in my dissertation so I have to search a lot for this topic and for this search my main resource is FBES (Faculty of Business, Environment and Society) which provides the best online business information services which is also including the digital management library. Some of the main sources (journal databases) for my research area are given below:
- EBSCO Business Source.
- Business Source Premiere.
- Science Direct.
Overall these cover hundreds of journals, and give access to up to a million journal articles.
While reviewing all the information from available literature on efficient market hypothesis, operations of stock market, price fluctuations and the anomalies of stock market, I have come to the conclusion that the following outcomes could be possible and predictable from my research,
- If the stock market is efficient then no information can play any role in making any change towards the performance of stock market.
- The efficient market hypothesis is expected to take any of the following forms which are weak, semi-strong and strong which purely depends upon the availability, and trueness of the past and present information about the stock concerned in the stock market.
- The anomalies like technical anomalies could be of great help to the researchers and analysts to predict the changing trend in the prices of stocks in the stock market but the transaction cost is the cause of concern while using such technical method.
- There are some other stock market anomalies which purely depend upon the internal and external factors of the entity and may result in fluctuations in the stock market.
- The anomalies related to stock market exist for short period of time but function against the concept of efficient market hypothesis and in my research I will find out the facts relating to the vibrations in the stock market as a result of these anomalies.
LIMITATIONS AND EXPECTED DIFFICULTIES:
While conducting my research I have to face certain difficulties and limitations which may occur during the course of my research. As my research involves the collection of secondary data, I have to be quite aware of the limitations that may arise due to the nature of data. Some of the limitations that are possible are as follows
- It could be possible that the theory and data we collected for our research is unclear and is not helpful for the companies in their decision making.
- It is important to check the source of the information as it could be wrong and misleading.
- It is possible that the theory is quite old for studies and research purposes in today’s rapidly developing world.
- The theory may not be fit for application due to development of new and technological methods and techniques used for the analysis.
- Chris R. Hensel and William T. Ziemba (1996)”Investment Results from Exploiting Turn-of-the-Month Effects,” Journal of Portfolio Management 22, 17-23
- Elearn – NetTel Financial Analysis Revised: Session 1: Market Efficiency
[Online] Available From: http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page4.htm
- Eugene Fama and Kenneth R. French (1992)”The Cross-section of Expected Stock Returns,” The Journal of Finance 47, 427-465.
- Eugene F. Fama (1995) “Random Walks in Stock Market Prices,” Financial Analysts Journal 21, 55-59.
- Ghauri, P., Gronhaug K and Kristianslund I., (1995) “Research methods in business studies – a practical guide” Hempstead: Prentice Hall
- Investor Home Historical Stock Market Anomolies
[Online] Available From: <http://www.investorhome.com/anomaly.htm>
- James P. O’Shaughnessy (1998) 2nd edn. What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time. New York: McGraw Hills
- Lawrence Harris (1986) “A Transaction Data Study of Weekly and Intradaily Patterns in Stock Returns,” Journal of Financial Economics 16, 99-117
- Loughran Tim (1997)”Book-to-Market across firm Size, Exchange, and seasonality: Is There an Effect?” Journal of Finance & Quantitative Analysis 32, 249-268
- Marc R. Reinganum (1997) “The Size Effect: Evidence and Potential Explanations,” Investing in Small-Cap and Microcap Securities, Association for Investment Management and Research, 1997.
- Robert Haugen and Philippe Jorion, (1996)”The January Effect: Still There after All These Years,” Financial Analysts Journal, January-February 1996.
- Srinivas Nippani and Anita K. Pennathur (2004) “Day-of-the-week effects in commercial paper yield rates.” Quaterly Review of economics & Finance 44, 508-520
- Werner F.M. DeBondtand Richard Thaler (1985)”Does the Stock Market Overreact?” The Journal of Finance 40, 793-805.
Cite This Work
To export a reference to this article please select a referencing stye below:
Related ServicesView all
DMCA / Removal Request
If you are the original writer of this essay and no longer wish to have your work published on UKEssays.com then please: