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26 Sep 2018

The efficient market hypothesis (EMH) holds that all securities are priced rationally in the market, that is, that prices fully reflect all available information. Because all information is contained in stock prices it is impossible to beat the market over time without taking on excess risk. Support or criticize the concept that markets are efficient.

2. Do prices in the stock market reflect all public information? Does everyone have access to this 'public' information? Is there a cost of acquiring this 'public' information? Why or why not?

3. Are there market imperfections? If so, discuss the possible causes of persisting market imperfections. If not, why not?

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Irving Heathcote
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29 Sep 2018

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Please write a 250 word response to the below discussion. Please provide 2 scholarly sources.

The efficient market hypothesis states that share prices reflect all relevant information, and that it is impossible to beat the market or achieve above-average returns on a sustainable basis. There are many critics of this theory, such as behavioral economists, who believe in inherent market inefficiencies. The Efficient Market Hypothesis (EMH) states that securities are very efficient in reflecting the truth about a stock. In other words, when new information is available about a stock, it is incorporated into the price adjustments of the stock quickly enough to reflect the actual state of the market (Malkiel, 2003). EHM debunks the idea that financial analysis and forecasting are useful tools to shop for stocks. In other words, because securities accurately reflect the status of that stock, it is not possible to use financial analysis to find an undervalued stock or predict trends in the market in order to buy low with the future insight to sell high. There are three levels, or degrees, of the efficient market hypothesis: weak, semi-strong, and strong. The weak form assumes that current stock prices reflect all available information, and that past price performance has no relationship with the future. In other words, this form of the hypothesis says that using technical analysis to achieve exceptional returns is impossible. The semi-strong form says that stock prices have factored in all available public information. Because of this, it's impossible to use fundamental analysis to choose stocks that will beat the market's returns. Finally, the strong form of the efficient market hypothesis says that all information, public as well as private, is incorporated into current stock prices. This form of the efficient market hypothesis essentially assumes a perfect market, and isn't plausible when there are insider trading restrictions (VanBergen, 2011). Yes, I believe that financial statement analysis can provide a significant advantage to an investor. The key is that empirical analysis, specifically statistical models aimed at forecasting future trends based on historical data, are simply another tool to be taken in to account. They are not a single source of the definitive answer. But, through the use of high power computing and mathematically rigorous modeling tools, forecasting is a powerful tool to provide additional insight to decision makers to include the financial industry. In support of my position, (Malkiel 2003) reports the findings of several empirical studies which demonstrate positive statistical correlations in short-run return analysis and the successful prediction of up to 40% of variation in long-term return analysis through time-series statistical models, which are able to take into account seasonal fluctuations (Malkiel 2003). One experimental study demonstrated with statistical significance that the Ohlson model provides predictive ability for future stock price movements (Lee, Chen and Tsai, 2014).

1. Which of the following statements about the OTC market istrue?

A. An OTC market is an organized exchange where there is acentral trading location.

B.

OTC security transactions are made on the floor of an exchangeby traders.

C.

Securities that are not listed on an organized exchange arebought and sold on the OTC market.

D.

Securities that are listed on an organized exchange are boughtand sold in the OTC market.

2. Which of the following theories states that security pricesreflect all information, whether public or private?

A. Weak-form efficiency.

B.

Semistrong-form efficiency.

C.

Nominal-form efficiency.

D.

Strong-form efficiency.

3. Which of the following is a primary investment vehicle forthe funds in which life insurance companies must invest?

A.Both equity securities and long-term corporate bonds.

B.

CDs.

C.

Equity securities.

D.

Long-term corporate bonds.

4. Large firms are most likely to use money markets for thefollowing reason:

A. To make long term investments.

B.

To buy commercial paper at lower interest rates than it couldsell through a bank.

C.

To finance long term investments.

D.

To adjust their liquidity position.

5. Which of the following is true of the New York StockExchange?

A. It is an organized exchange.

B.

It has no central trading location.

C.

It is an over-the-counter exchange.

D.

It can be used by all U.S citizens.

6. Which of the following is true of an efficient market?

A. Market prices of securities of companies in the same industryare all same.

B.

Market prices adjust quickly to new information as it becomesavailable.

C. All information contained in past prices of a security isreflected in its current price but that there is both public andprivate information that is not.

D.

Securities have no systematic risk.

The valuation models we have been looking at rely in part on the idea that markets are efficient, i.e., that markets respond instantaneously to information, and thus prices that ex
ist are fair. The Efficient Market Hypothesis, which was developed by Eugene Fama of the University of Chicago in the 1960s, is the formal realization of this idea. This simple but powerful idea has been a solid backbone for the study of corporate finance and securities valuation for several decades. However, several noted economists, including Robert Schiller, have stated that the Efficient Market Hypothesis is dead. There are many articles about this - look at what Paul Krugman and others are writing. Do you agree? And if EMH is no longer valid, are the valuation models no longer an appropriate point of study? Please provide links to all of your sources - you many want to utilize the virtual student lounge as a place to test some of your ideas.

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