The efficient store Hypothesis

Managers - The efficient store Hypothesis

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(1). Stock prices supervene a random walk.

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When researchers have examined stock prices movement for quoted clubs they have observed that the price movements seem to supervene a random pattern. In other words, stock price movements cannot be predicated.

From their observations, a hypothesis was developed which stated that stock prices are fairly valued on the basis of all existing data and stock prices speedily react to any new information. Being fairly valued means that unbelievable returns equal required returns, taking into list the level of risk. This is referred to as an efficient capital market.
This would be unbelievable given the large number of behalf seeking investors analyzing stocks independently of one another. In may be referred to as the fair game model.

(2). Stock prices write back to new information.

Stock prices will move new when new data is received and will fairly reflect that new data since new data must, by definition, be unpredictable and random (otherwise it would not be new information), it follows that stock price movements will also be random. Stock prices adjust rapidly to new data agreeing to the efficient market hypothesis (Emh).

This is referred to as informational efficiency.

(3). Assumptions underlying efficient capital markets.

The premises underlying the hypothesis that prices adjust rapidly to reflect all data are as follows,

1. A large number of market participants are competitive to analyze and value securities in order to make profits.

2. Information comes to the market in a random fashion. Timing of an notification is independent of other announcements.

3. Competing investors speedily react to this new data in setting stock prices. The reaction may be imperfect, important to an over or under-reaction to the new information. Any way there is no bias in one direction.

Generally, efficient capital markets therefore imply a minimum number of investors and a high degree of trading.

(4). The three forms of the Emh.

1. To what data do stock prices respond?

Various levels of the Emh have been developed which state that markets take accounts of different levels. These are ordinarily referred to as the weak. Semi strong and strong forms of the Emh.

2. Weak form of the Emh.

The weak form of the Emh stats that all securities market data has already been incorporated into the current stock price. market data includes share price movements, volumes, the nature of buyers and selves, etc.

What this implies is that it is impossible to use past stock price movements and other historic market data to predict time to come price movements.

This form of the Emh directly contradicts technical prognosis assumptions implicitly, technical analysts believe that markets are not efficient, since they are using market data to make venture decisions.

3. Semi-strong from of the Emh.

The semi-strong form of the Emh stats that current stock prices not only reflect the market data referred to In the weak form but also rapidly move to merge any non market data that has been published about a company, i.e. The price reflects all communal information.

For example, issue of preliminary figures by the firm constitutes new data and the stock price will move to reflect this. Other communal data is incorporated in ratios such as price to book value, P/E ratios. Ect.

This suggests that investors who base venture decisions on data after the data has been made communal will not make excess returns on average.

4. Strong form of the Emh.

The strong form of the Emh stats that, in addition to published information, a company's stock price reflects all data that can be gleaned about the firm itself, its markets and general economic factors. It includes those facts that are meant to be underground and confidential to the firm itself.

Effectively, the strong form extends the efficient market to encompass the perfect market, where data is freely ready to all investors at not cost and at the same time.
This form of the Emh is very ultimate and few citizen precisely believe that it applies in practice. The very fact that stock prices move when previously confidential data is published indicates that it is not the case.

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