The Forms of Efficient Market Hypothesis

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1 THE FORMS OF EFFICIENT MARKET HYPOTHESIS 1.1 Introduction In the capital market, values of stocks and bonds can fluctuate widely from year to year. A reason why this occurs is new information; as new information arrives inves-tors reassess asset values based on that information. A financial market is efficient when market prices reflect all available information about value, the economy, financial markets, and the specific companies involved. The efficient markets hypothesis (EMH), is the proposition that current prices on the stock exchange fully reflect available information about the value of the firm, and there is no way to earn excess profits, (more than the market overall), by using this information. The driving forces behind market efficiency are: • Self-interest - as investors seek undervalued securities to buy and overvalued securities to sell. The more participants there are in a market and the more rapid the release of information, the more efficient a market is said to be. • Competition among investors - Many individuals spend their entire lives try-ing to find mispriced stocks. They gather information on companies powerful-ly incentivised by the profit motive. Therefore because of competition among investors, the market will become increasingly efficient. A kind of equilibrium comes into being with which there is just enough mispricing around for those who are best at identifying it to make a living at it. There are, however, different kinds of information that influence security values, thus, consequently, financial researchers distinguish among three versions of the Efficient Markets Hypothesis, depending on what is meant by the term “all available information”. 1.2 Weak Form Efficiency The weak form of the efficient markets hypothesis asserts that the current price fully incorporates information contained in the past history

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