effeciency market hypothesis

Prepared by: Abdulkadir TifowCourse Name: Financial Theory and Economic applicationProf: Dr: Güven SevilAcademic year: 2013/2014

The Efficient market Hypothesis (EMH) term was developed by Professor Eugene Fama in 1960‘s. and he had modified for the theory in 1970.

The Efficient Market Hypothesis states that the price of a financial asset reflects all available public information.

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1. What is “all available information”?

2. How the new information affects the stock prices?

Example. Suppose that Merck announces a new allergy

drug that could completely prevent hay-fever. How should the share price of Merck react to this news?

Consider three hypothetical paths for price adjustments:

1. Increase immediately to a new equilibrium level

2. Increase gradually to the new equilibrium level

3. First over-shoot and then settle back to new equilibrium level.

Stock Price

-30 -20 -10 0 +10 +20 +30

Days before (-) and after (+)

announcement

Efficient market response to “good news”

Overreaction to “good news” with reversion

Delayed response to

“good news”

Stock Price

-30 -20 -10 0 +10 +20 +30

Days before (-) and after (+)

announcement

Efficient market response to “bad news”

Overreaction to “bad news” with reversion

Delayed response to “bad news”

Number of Market Participants

Availability of Information

Limits of trading

Transaction costs

Information costs

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Perfect Capital Markets are characterized by the following attributes:

1)Information is equally available without cost to all traders

2)Security prices are independent of individual buyers, sellers and issuers

3)Transactions costs are zero- there are no brokerage fees, transfer taxes, or other transaction cost incurred when securities are exchanged.

Technical Analysis: is a security analysis methodology for forecasting the direction of prices through the study of past market data.

Fundemental Analysis: A method of security valuation which involves examining the company's financials and operations, especially sales, earnings, growth potential, assets, debt,products and Competition.

Weak form

Semi-strong form

Strong form

The Weak form effeciency forms İmplies that all historical price and volume data for securities are reflected in price.

Implication:Investors can not use technical analysis to

get economical profit predict and beat a market.

The Semistrong-form reflect all publicly available information:

o Historical price data, total trading volume data, rates of return

o Earning reportso New product develeopmentso Marketing plans and Dividend payments…e.t.c

Implications: an investor cannot use fundemental analysis to economical profit.

The strong-form efficient market hypothesis assumes that that security prices reflect all both public and private information available.

Implication: Investors cannot base their investment

decisions on technical analysis, fundamental analysis or inside information.

Market manipulation is a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price of, or market for, a security, commodity or currency

Pump and dump

Painting the Tape

Wash trade

Bear raid

Churning

Speculation in the stock market is when someone believes a stock or commodity is going to up. Taking large risks, especially with respect to trying to predict the future; gambling, in the hopes of making quick and large gains.

Speculators are people who analyze and forecast futures price movement, trading contracts with the hope of making a profit. Speculators put their money at risk and must be prepared to accept outright losses in the futures market.

If the speculation is Positive, they buy or sell. If the speculation is negative they don’t buy or sell.

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Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.

Hedger: An individual that participate in purchasing investments to hedge against one another to obtain the maximum level or profit and security against price movements.

Speculator Hedger

People who buy and sell the future contracts by predicting the future prices goes up

People who buy and sell the actual commodities can use the futures markets to protect themselves from commodity prices that move against them. They’re called hedgers.

Speculators accept risk in the futures markets, trying to profit from price changes.

Hedgers use the futures markets to avoid risk, protecting themselves against price changes.

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