Contrast the ‘Adaptive Markets Hypothesis’ with the ‘Efficient Markets Hypothesis’, being careful to assess their respective strengths and weaknesses.
In recent years the effectiveness of the Efficient Market Hypothesis (EMH) has been substantially questioned by the financial economists and a new theory related to the market behaviour, known as the Adaptive Market Hypothesis (AMH), was proposed. In order to critically assess and contrast these theories it is necessary not only to define them, but also to discuss their respective strengths and weaknesses.
The EMH is a financial theory asserting that market prices fully and rationally reflect all available information at all times, immediately adjusting …show more content…
Consequently, Eugene Fama stated that a market is efficient if “prices always fully reflect all available information“ (Fama (1969), p.383). This implies that the stock market is efficient if a change in available information will immediately change the stock prices and no under-priced or over-priced stocks are present in the stock market. The price of the stock is always the best estimate of its value. Hence, being smart is not an advantage in investing. A portfolio chosen randomly might as well achieve higher returns than a portfolio wisely selected. An investor cannot earn abnormal profit by using information relevant to the stock. Even professional investors are unable to outperform the market (Shiller (2015), p.197). The concept of the EMH is that if there were any arbitrage opportunities available, they would already be taken as there are constantly active managers searching for mispriced stocks, which in the end results in the markets being efficient. This theory assumes that all investors act form rational