Compare the Efficient Markets Hypothesis with Other Theories of Pricing in Financial Markets

2293 Words Sep 1st, 2015 10 Pages
EFFICIENT MARKETS HYPOTHESIS AND OTHER THEORIES OF PRICING IN FINANCIAL MARKETS

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Efficient Markets Hypothesis and other theories of pricing in financial markets
Efficient market hypothesis (EMH) is a theory that emerged in the 1960s. It states that it is difficult to predict the market since the price has been set and reflect the current market conditions. It is a disputed and controversial theory. The theory is comparable to other theories of pricing in financial markets. Several strengths and shortcomings emerge through comparison with other theories of pricing (Blinder, et al., 2012). EMH states that no stock is a better buy when compared to others. It is the conclusion that leads to
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The argument against EMH is that a large number of investors base their expectations on past earnings, prices, records and other indicators. Since stock prices relate to the exceptions for the investors, it is only applicable that future price influence stock prices.
Evidence collected in the past ten years suggest that there is an excess volatility in stock markets. Stock prices regularly change from their fundamental values. The empirical results have led to several alternative theories to detail the observed volatility. It includes fads and noise trading. For instance, the stock market crash that occurred in 1987 led economists to reassess the validity of the EMH (Alexander & Moloney, 2011). An implication of the EMH is that stock price tends to follow a random walk. In essence, the change occurring in the stock prices is difficult to predict. If, based on the information available, a person can determine that the stock price by 10% tomorrow, then the stock market must be failing to incorporate that information (Collum, 2014).
To understand the EMH, changes in the stock market should undergo analysis. When picking stocks, the investor will identify those whose prices are bound to rise in future. In this regard, it is much easier to earn capital gains when the increase occurs. If the forecast is right, then the returns will exceed those in a random selection of stocks (Toporowski, 2010). On the other hand, the EMH says that such a

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