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The Efficient Markets Hypothesis

The Efficient Markets Hypothesis

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The theory of Efficient Markets Hypothesis (EMH) asserts that (1) stocks are always in equilibrium and (2) it is impossible for an investor to “beat the market” and consistently earn a higher rate of return than is justified by the stock’s risk.
The theory of Efficient Markets Hypothesis (EMH) asserts that (1) stocks are always in equilibrium and (2) it is impossible for an investor to “beat the market” and consistently earn a higher rate of return than is justified by the stock’s risk.

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Published by: ClassOf1.com on Jul 26, 2013
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Finance
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Sub: Finance Topic: Market Hypothesis
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The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not forsubmitting the same in lieu of their academic submissions for grades.
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The Efficient Markets Hypothesis
The theory of 
Efficient Markets Hypothesis
(EMH) asserts that (1) stocks
are always in equilibrium and (2) it is impossible for an investor to “beat themarket” and consistently earn a higher rate of return than is justified by thestock’s risk. Those who believe in the EMH note that th
ere are 100,000 or sofulltime, highly trained, professional analysts and traders operating in themarket, while there are fewer than 3,000 major stocks. Therefore, if each analystfollowed 30 stocks (which is about right, as analysts tend to specialize in aspecific industry), there would on average be 1,000 analysts following eachstock. The forms of EMH are;
 
 Weak-Form Efficiency 
Technical analysts believe that past trends or patterns in stock prices can be used to predict future stock prices. In contrast, those who believe in the weak form of the EMH argue that all information contained in past pricemovements is fully reflected in current market prices. If the weak form were true, then information about recent trends in stock prices would be of no use in selecting stocks
the fact that a stock has risen for the past threedays.
 
 
Sub: Finance Topic: Market Hypothesis
*
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not forsubmitting the same in lieu of their academic submissions for grades.
Finance Homework Help from Classof1.com
For example
, would give us no useful clues as to what it will do today ortomorrow. Those who believe that weak-form efficiency exists also believethat technical
analysts, also known as “chartists,” are wasting their time.
 
 
Semi strong-Form Efficiency 
The semi-strong form of the EMH states that current market prices reflectall publicly available information. Therefore, if semi-strong-form efficiency exists, it would do no good to pore over annual reports or other publisheddata because market prices would have adjusted to any good or bad newscontained in such reports back when the news came out. With semi-strong-form efficiency, investors should expect to earn the returnspredicted by the SML, but they should not expect to do any better or worseother than by chance. Another implication of semi-strong-form efficiency is that whenever information is released to the public, stock prices willrespond only if the information is different from what had been expected.
For example
, if a company announces a 30% increase in earnings and if that increase is about what analysts had been expecting, then the
announcement should have little or no effect on the company’s stock 
price.On the other hand, the stock price would probably fall if analysts hadexpected earnings to increase by more than 30%, but it probably wouldrise if they had expected a smaller increase.

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