Efficient Market Theory Essay Example | Topics and Well Written Essays - 1750 words

Efficient Market Theory - Essay Example Any information, whether published or insider, will reflect in the prices instantly. This hypothesis presupposes that there is no question of under or overvaluation in the market and it is impossible to outperform the market by making abnormal profits in the stock exchanges. It is also pertinent to note that higher returns are associated with higher risks, and the factors affecting performance of a stock could vary from political risks, acquisitions and mergers, crisis of various sorts to fluctuations in other markets, and it may be difficult for the market forces to adjust to the impact of these factors instantly. Objectives This paper seeks to study and analyze the secondary sources with reference to the following questions relevant to efficient markets theory: 1. Is the Efficient Market theory true? 2. Is there any need for technical or fundamental analysis in efficient markets? Efficient Market Theory If beating the market is impossible, how come Warren Buffet is consistent in ou tperforming the market? There are so many mutual fund and portfolio managers giving consistent performance in the stock markets, which is not possible according to this theory. There is always scope for outperforming the markets thorough experience, expertise, intuition and discipline. The efficient market is an ideal situation which is hardly achieved in the real life. For example, Muhammad, N. M. N. and Rahman, N. M. N. A. (2010, p. 35) writes â€Å"EMH states that security prices fully reflect all available information and will immediately adjust to the arrival of new information (Adam, 2004). However, since market was closed on both Saturday and Sunday, it was argued that investors cannot do anything with the market even though they got some information during the weekend†. The equilibrium in the market is always disturbed by so many factors including psychological factors such as over confidence of the investors or over reaction to the market forces. Sharma, A. (2009, p. 37) states â€Å"Various studies have been conducted worldwide on stock market reaction to public announcements. Market’s reaction to such publicly available information is very swift. Inefficiency in the market exists when investors envisage such information before it is formally announced and earn abnormal returns†. Greed and fear are the motivating forces of the markets many a times, and rational approach to the investment or trading takes the backseat. Sudden crashes in the markets are nothing to do with fair value, and the market sentiments driven by so many factors rudely shakeup the very fundamental concept of this theory. Consequently, the question of under or overvaluation to the stock arises in the markets. Park, A. (2010, p. 365) states that one of the implications of the weak-form EMH is that prices are submartingale, or, more loosely, they are a random walk. Consequently, a so-called technical analysis, which is the extraction of information about the fut ure movement of prices from past prices, should have no merit. In real life situations, perfect efficiency in the market place is unrealistic, and it also depends upon accuracy of the information, cost of the information, the efficiency of the information transmission and the risk-return reward in taking decisions based on the information. Livanas, J. (2006, p. 28) argues how can the market be efficient when investors seem to make decisions that perhaps are rational – but only within bounds? When the investors make decisions in an irrational manner, which is in line with the human behavior, it will be difficult to rely on a