Last Updated 08 Jul 2021

Math problem: efficient market hypothesis

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Financial market is a market for buying and selling of capital and credit securities. It consists of the money market which is the trade of short term securities that mature in less than a year such as treasury bills and capital market which consists of trade of long term assets with maturity period of more that one year. Financial market security valuation essentially reflects the maximum discounted price the traders are willing to pay at present time for future cash payments taking into consideration uncertainty and market projections (Han, 2002).

Therefore, valuation of current security prices accounts for uncertainty and thus a higher interest rate or return is included to compensate uncertainty in the financial market. Uncertainty in the financial market introduces forecasting and market projections thus investors fundamentally base their decisions on available information about the securities in the market. According to Han, (2002) “what investors are trading is actually information as a "commodity" in financial market for the future cash flows and information about the degree of certainty”.

There are several theories that postulate decision making and the nature of financial market, one of the most important theories is efficient market hypothesis (EMH). This paper is an evaluation strength and weaknesses of EMH theory as it is applied in the market by testing the theory using statistical data of Britain and world Returns from the financial markets. Efficient Market Hypothesis (EMH). EMH postulates that in an efficient market available information is quickly assimilated in to the valuation of the security so that current prices reflect all available information in the market.

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Thus, the hypothesis stipulates that prices at any point in time reflect all past information thus it would be useless to analyze past information to predict future price movements in an efficient market. There are various versions of EMH that have different implications as far as market prediction and future price movement are concerned;

  • The weak version of EMH holds that current asset prices in the market fully reflect the past information; it is named weak because it considers past prices only, it simply implies that one cannot benefit from what everybody knows.
  • The semi strong form considers public information and financial reports and holds that nobody can benefit from what is already known and from the financial statements released in the market.
  • The strong form of EMH holds that in an efficient markets both public and private information (Insider information). It holds that the market assimilates the information too quickly thus even insider information cannot be used to make super-normal profit. (Han, 2002 & Khan, 2004).
Math problem: efficient market hypothesis essay

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