Efficient Market Hypothesis

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The efficient market hypothesis(EMH) was originally considered by an American economist Eugene Fama in 1965. Around 1970s, the EMH had achieved its dominance among economic theories and had became the base of outstanding financial models and assumptions. (Shiller, 2003) In the financial field, CAPM (Capital Asset Pricing Model) was propounded by Robert Merton in 1973. As for the economic area, Robert Lucas had published “Assets Prices in an Exchange Economy” in 1978. It can be seen that this prominent conception had successfully linked finance with economy in one specific theory. This essay will explain the general definition and features of efficient markets and go on illustrate three various versions of efficient market hypothesis. Furthermore, …show more content…
(Levy & Post, 2004) In other words, information is a core factor of an efficient market because it indirectly affects the analysis of the stock prices. For instance, the weather forecast predicts a hard freeze this year and this information will be devastating to Tropicana Company as the production of orange may decrease due to the freeze, as a result, risks of losses may increase at the same time. Additionally, it is possible that the stock will devaluated because of the negative information which leads investors undersell stocks of Tropicana Company. Finally, the selling pressure will drive the stock prices down to its initial value as the new information has entirely reflected in the stock …show more content…
In order to achieve more abnormal returns, corporate managers can take advantages of market anomalies – the size effect, the value effect and the momentum effect during the the process of making decisions. (Fama & French, 1992) The size effects indicates that small firms with small capitalization tend to outperform than large firms with earning positive abnormal returns, while the large firms with high market value are gaining negative returns. This is because the size and the beta is deeply correlated. (Banz, 1981) By contrast, small firms typically have higher betas or sensitivity than large firms, which tend to own stock prices with lower volatilities. That is how company sizes affect the judges of investors or corporate managers. Moreover, the value effect also prevails in the efficient market and corporate managers could benefit from it as well. It denotes the value stocks generally have higher average rates of abnormal return than the growth stocks. (Chan, 1991) Incidentally, corporate managers and investors are able to distinguish value stocks and growth stocks through comparing their market values. For further information, the statistic of abnormal return on value stocks is at about 4% to 6% per annum. (Levy & Post, 2004) The momentum effects implies a tendency for investors who have not react to new relevant information fully will cause a

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