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The Controversy over Efficient Capital Markets

In: Business and Management

Submitted By mnmonwar1
Words 990
Pages 4
Discussing the empirical evidence supportive of and against market efficiency.
Stock prices changes are said to have a similar distribution and sovereign of each other, meaning that they follow a random pattern and past movement and trends cannot be used to predict future price of a stock. Efficient market hypothesis (EMH) states that beating the market consistently is impossible as stock market efficiency causes existing share prices to always show and reflect all relevant information available in the market. According to the theory stock will always trade at their fair value on stock exchange, making it impossible for investors to purchase undervalued stocks or sell overpriced stock. But recent research has proved that gaining an abnormal profit is possible to some extent.
EMH depends heavily on the level of information available in the market. In weak form efficiency all the past price movements is fully incorporated in current market price so technical analysis might not be used to predict and beat a market. While in a semi strong efficiency all public information is calculated into a stock’s current share price and in the strong form efficiency all private and public information is accounted in a stock price.
Research has shown that market is efficient in all these forms. In weak form efficiency the random walk hypothesis1 is tested by testing the connection between the current return on a stock and the return on the same stock over a previous period. A positive serial connection specifies that higher than average returns are likely to be followed by a higher than average return while a negative serial means higher than average is followed by lower than average return. In 1965 Fama found that serial correlation coefficient for 30 Dow Jones stocks were not enough to even cover the transaction cost and gains were too little to make market inefficient2.

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