Efficient Market Hypothesis:
------ general remarks
Traditional finance theory including two major concepts,one is portfolio and CAPM theory,the other is EMH.They are interaction and develop hand in hand.
In the 1970s,EMH Gradually developed and to form a series of theories,it assumes that investors can make response quickly and unbiased to the information,and the price of assets reflects all of the public information completely.Of course,the premise is: 1.The investors are rational,so they can evaluate assets rationally and make the right capital investment decision. 2.The transaction is randomly,so even the investors are not rational completely,their transaction which influence the price can be neglected because the randomicity of their transaction. 3.The activity of arbitrage is efficient.we can't get the conclusion of EMH until we have these assumptions.
To handle differential response rates,we must admit that certain information may affect stock prices more quickly than other information and they are grouped into three categories:1.Information on past prices,it reflects the predictive ability to the future earnings through earnings in the past,and it is said to satisfy weak form efficiency.Since the information only reflects the past prices,so investors can't obtain super-profit through using the historical price information.2.Publicly available information.It tests the response rate of securities to all of the publicly available information,including information such as earnings announcement for the firm as well as the statement of stock split and so on,it is semi-strong form efficiency.If it is true, then investors not only can't abtain super-profit from historical price information,but also can't abtain super-profit through analyzing the current available information.We can prove it from the following example:
HuiYuan Juice announced that ABN AMRO would be the representative of the wholly-owned subsidiary of Coca-Cola Company to buy HuiYuan Juice Group Ltd.for HK$17.9 billion ($2.3 billion) sept 3,2008.From above chart can be seen,the stock price rose about 150%.In fact,HuiYuan shares rose to HK$11.06 from HK$4.14just after the announcement made,and this is match up to the semi-strong form efficiency of EMH:before the announcement of purchasing was released,the stock price start to increase,because the news have been influencing the stock price,and when the announcement was released formally, the stock price increased sharply.It indicates that the stock price of target company makes an appropriate response to the news of acquisition.3.All information.A market is strong form efficient if prices reflect all information,public or private.It assumes that any investor or institution can't get the monopoly power of information which is relevant to the price,namely,you unable obtain super-profit even you have the inside information.Fair to say,most of assessment is focused on the types of weak form efficiency and semi-strong form efficiency.Did not seize the extreme view of strong form efficient which claims that investors can't obtain super-profit using the inside information.
After talking about EMH responses to information quickly and accurately,next let's discuss another problem of EMH:the prices remain the same if no information has changed,or,stale information can't make money.To prove the stale information can't make money,we must define the stale information and make money at first.The former is easy to understand,and in finance,make money is to obtain superprofit after risk-adjusted.So,even if you obtain super-profit by making use of the stale information through adopting some special strategies ,it also can't prove that the market lacks of efficiency.To obtain super-profit,investors must bear risk,therefore,the super-profits just is the reasonable reward to bear the risk.Now,the problem is how to calculate the risk within a special strategy of investment,CAPM-we just learned in the last chapter-is accepted widely.However,CAPM is not the only model to calculate risk.The problem about the prices remain the same if no information has changed is so complex that it is still argued by many economists.Moreover,different economist gives the stale information different meaning.
According to the theory of EMH,it's ineffective no matter what methods or how to select stocks,namely,the reward of investment can't exceed the average return of market.Obviously,the actual situation does not support this theory.Firstly,insider trading and inside information can't be eliminated completely,there are some investors who master more information than others at all time.Secondly,even if it is more fair to get the market information,every investor would hold the different opinion and expectation to the information, and this would lead the stock prices to stray away from the real value.For example,those who such as Buffett and Peter Lynch can always beat the market through finding the failure of stock pricing have offered a challenge to the theory of EMH. Many members of the academic community including Prof. Shleifer argue that none of the three conditions are likely to hold in reality.
Based on traditional finance theory,it seems that EMH can stand any test so that some scholars believe the EMH is one of the best hypotheses in the financial theory.However,one point of view is based on what is called behavioral finance doubts the theory of EMH.1.Arbitrage.EMH considers the real prices equal the basic values,this point is based on two basic assumptions:Firstly,one attractive chance of investment would appear if the price is under or over of the basic value.Secondly,rational investors know the securities are mispriced and can grab the chance at once to correct the mispricing.However,designing a strategy to correct the mispricing may be full of risk and the cost is so high that it's impossible to eliminate the mispricing.Since the arbitrage is limited,so mispricing is impossible to disappear.2.Rationality.EMH assumes the investors are rational completely,they dislike the risk and pursue the profit maximization.In reality,however,people are not really rational,for example,gambling,gambler may not care the situation of final wealth,what they care more may be the process of Winning or losing.In the side of investment,investors often use their feeling to expect the future instead of using the model which is required in the traditional finance theory to correct their judgement.In addition,investors' decision is influenced by many other things such as framework of personal's understanding.
In conclusion,EMH establishes the basis for researching the Pricing mechanism of securities as well as the change of Expected earnings in capital market.It is the milestone of modern theory of the securities market,it must be helpful to the development of capital market in our country.