Question

Define the efficient market hypothesis (EMH). Discuss the real world evidence for the EMH, including differences across countries. Identify investment behaviors and trading biases that suggest investors ignore the evidence supporting the EMH.

Answer 1

Efficient market hypothesis is a theory that advocates that all such public as well as private information related to companies are already discounted in its share price. This theory is a passive investment theory which advocates that an investor cannot beat the market by investing into different securities because there is no scope for any overvaluation and undervaluation of securities as securities are already perfectly valued because of the discounting of all available informations which may be public or maybe private in nature.

Efficient market hypothesis doesn't require investors to be rational but it advocates in the long run investors can never beat the market rate of return because the securities already reflects all price sensitive information whether public or private.

Real world examples of efficient market hypothesis can be seen as the earning reports as well as the insider trading as well as various other news which are already bought in before they strike the market.

To give an example recently Facebook invested 10% stake in Reliance jio and the day before the news came out the Reliance shares spiked almost 10% from lows at the end of the trading day, people knew it in advance before it strike the market. This is an example of semi efficient form of efficient market hypothesis which advocates that all public information are already discounted but there is room for private information to make money through insider trading.

Short term traders believes that they can beat the market by predicting the behaviour of different stock through charts and technical analysis so they completely ignore the theory of efficient market hypothesis they believe that stock prices can be predicted in advance and based upon the analysis it is easy to beat the market rate of return.

There are also techno funda investors who invest for short as well as medium term who believes that based upon a mix of technical education as fundamental analysis they can beat the market rate of return as fundamental and chart predict the future behaviour of stock prices in advance.

So it can be said that efficient market theory has its supporters as well as people who object to it.