Efficient Market Essay

1479 Words6 Pages
Explain what is meant by the concept ‘efficient market hypothesis’ and discuss its limitations when applied in practice. 1 INTRODUCTION In 1965, Fama published an article where the concept of efficient market appeared first time. And Fama (1970) proposed the efficient market hypothesis, which considered the efficient market as a market where the market prices could fully reflect the market information. The EMH could be regarded as a milestone in the development of financial economics, which also has a very far-reaching impact on modern economics. However, in the past 50 years, a matter of controversy about EMH has still not been resolved. People could often discover that EMH does not reflect the market’s authenticity when applied in practice with some limitations. Taking the stock-market of China as an example, Groenewold et al. (2004) argued that the EMH could be not suitable when the stock-market in China lacks liquidity which means market prices are not fair. In this paper, in order to explore why the EMH presents inadaptability, the limitations would be given a deeper discussion, and find out the reasons. 2 EFFICIENT MARKET HYPOTHESIS Fama (1970) indicates that an efficient market is a market where there are large numbers of rational, profit-maximizing participants actively competing with each other, trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. Another important concept is about market efficiency which refers to the aspects of operation, information and allocation in capital market. And the EMH focuses more on the informational efficiency. 3 LIMITATIONS OF THE EMH From the definition of the EMH, it was proposed on the basis of five conditions including: “zero transaction cost”, “freely available information”, “perfect competition”, the rational
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