What does the efficient market hypothesis (EMH) say about security prices, their reaction to new information, and investor opportunities to profit? What is the behavioral finance challenge to this hypothesis?

Do you personally believe the EMH argument or the behaviorist argument? Why and please be specific in your initial response.

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Nestor RutherfordLv2

28 Sep 2019

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The valuation models we have been looking at rely in part on the idea that markets are efficient, i.e., that markets respond instantaneously to information, and thus prices that ex
ist are fair. The Efficient Market Hypothesis, which was developed by Eugene Fama of the University of Chicago in the 1960s, is the formal realization of this idea. This simple but powerful idea has been a solid backbone for the study of corporate finance and securities valuation for several decades. However, several noted economists, including Robert Schiller, have stated that the Efficient Market Hypothesis is dead. There are many articles about this - look at what Paul Krugman and others are writing. Do you agree? And if EMH is no longer valid, are the valuation models no longer an appropriate point of study? Please provide links to all of your sources - you many want to utilize the virtual student lounge as a place to test some of your ideas.

Please write a 250 word response to the below discussion. Please provide 2 scholarly sources.

The efficient market hypothesis states that share prices reflect all relevant information, and that it is impossible to beat the market or achieve above-average returns on a sustainable basis. There are many critics of this theory, such as behavioral economists, who believe in inherent market inefficiencies. The Efficient Market Hypothesis (EMH) states that securities are very efficient in reflecting the truth about a stock. In other words, when new information is available about a stock, it is incorporated into the price adjustments of the stock quickly enough to reflect the actual state of the market (Malkiel, 2003). EHM debunks the idea that financial analysis and forecasting are useful tools to shop for stocks. In other words, because securities accurately reflect the status of that stock, it is not possible to use financial analysis to find an undervalued stock or predict trends in the market in order to buy low with the future insight to sell high. There are three levels, or degrees, of the efficient market hypothesis: weak, semi-strong, and strong. The weak form assumes that current stock prices reflect all available information, and that past price performance has no relationship with the future. In other words, this form of the hypothesis says that using technical analysis to achieve exceptional returns is impossible. The semi-strong form says that stock prices have factored in all available public information. Because of this, it's impossible to use fundamental analysis to choose stocks that will beat the market's returns. Finally, the strong form of the efficient market hypothesis says that all information, public as well as private, is incorporated into current stock prices. This form of the efficient market hypothesis essentially assumes a perfect market, and isn't plausible when there are insider trading restrictions (VanBergen, 2011). Yes, I believe that financial statement analysis can provide a significant advantage to an investor. The key is that empirical analysis, specifically statistical models aimed at forecasting future trends based on historical data, are simply another tool to be taken in to account. They are not a single source of the definitive answer. But, through the use of high power computing and mathematically rigorous modeling tools, forecasting is a powerful tool to provide additional insight to decision makers to include the financial industry. In support of my position, (Malkiel 2003) reports the findings of several empirical studies which demonstrate positive statistical correlations in short-run return analysis and the successful prediction of up to 40% of variation in long-term return analysis through time-series statistical models, which are able to take into account seasonal fluctuations (Malkiel 2003). One experimental study demonstrated with statistical significance that the Ohlson model provides predictive ability for future stock price movements (Lee, Chen and Tsai, 2014).

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True or False Questions:

1. Financial Advisors are not influenced by crowd behavior.

2. Most professional money managers do better than their benchmarks (e.g., S&P 500 index).

3. Technical analysis assumes that fundamental information about the market is already reflected in the market and the market activity.

4. Investor sentiment is the most important indicator when analyzing a financial market.

5. If your friend tells you that he is "long gold," it means that he has invested in gold with an expectation of the price rising.

6. Market bubbles have only occurred in the US.

7. If your forecast for a particular market is correct, you will always make money.

8. The Efficient Market Hypothesis is the foundation of George Soros' investment philosophy.

9. Ken Fisher's market forecasts are always accurate.

10. Behavioral finance is about how people are theoretically supposed to behave with respect to financial markets.

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