THEORY OF STOCK

MARKET EFFICIENCY
Eugene Fame (1965)
 GROUP MEMBERS
• Muhammad Ibtehaj Khan EC-048

• Muhammad Azhar Khan EC-044

• Samreen Amjad Markatia EC-073

• Sadaf Nadeem EC-034

 EUGENE FAMA
• Eugene Fama shared the 2013 Nobel Prize in Economic Sciences with Robert
Shiller and Lars Peter Hansen. The three received the prize for their “empirical analysis
of stock prices

• His major early contribution was to show that stock markets are efficient.*(See
comments)

• Fama has played a key role in the development of modern finance, with major
contributions to a broad range of topics within the field, beginning with his seminal
work on the efficient market hypothesis (EMH) and stock market behavior
 INTRODUCTION

• An efficient capital market is a market that is efficient in processing

information.

• In other words, the market quickly and correctly adjusts to new information.

• In an information of efficient market, the prices of securities observed at any

time are based on “correct” evaluation of all information available at that
time.

• Therefore, in an efficient market, prices immediately and fully reflect

available information.
 STOCK MARKET EFFICIENCY

• “Market efficiency refers to the degree to which market prices reflect all
available, relevant information”.

• If markets are efficient, then all information is already incorporated into

prices, and so there is no way to "beat" the market because there are no
undervalued or overvalued securities available.
 EFFICIENT MARKET HYPOTHESIS
(EMH)
The Efficient Markets Hypothesis (EMH) is made up of three progressively
stronger forms:

1. Weak Form

2. Semi-strong Form

3. Strong Form
 WEAK FORM
• The weak form of the EMH says that past prices, volume, and other market
statistics provide no information that can be used to predict future prices.
• If stock price changes are random, then past prices cannot be used to
forecast future prices.
• Price changes should be random because it is information that drives these
changes, and information arrives randomly.
• Prices should change very quickly and to the correct level when new
information arrives.
• This form of the EMH, if correct, repudiates technical analysis.
• Most research supports the notion that the markets are weak form efficient.
 SEMI-STRONG FORM

• The semi-strong form says that prices fully reflect all publicly available
information and expectations about the future.

• This suggests that prices adjust very rapidly to new information, and that old
information cannot be used to earn superior returns.

• The semi-strong form, if correct, repudiates fundamental analysis.

• Most studies find that the markets are reasonably efficient in this sense, but
the evidence is somewhat mixed.
 STRONG FORM

• The strong form says that prices fully reflect all information, whether publicly
available or not.

• Even the knowledge of material, non-public information cannot be used to

earn superior results.

• Most studies have found that the markets are not efficient in this sense.
 DRAWBACKS
• Speculative Economic Bubbles is a spike in asset values within a
particular industry, commodity, or asset class that is fueled by
speculation as opposed to fundamentals of that asset class
• Transaction Cost represent the labor required to bring a good or service
to market, giving rise to entire industries dedicated to facilitating
exchanges. In a financial sense, transaction costs include
brokers' commissions and spreads, which are the differences between
the price the dealer paid for a security and the price the buyer pays.
• Cognitive Biases generally involve decision making based on
established concepts that may or may not be accurate. Think of a
cognitive bias as a rule of thumb that may or may not be factual.
 STAKEHOLDERS OF THEORY
• There are several versions of EMH that determine just how strict the assumptions
needed to hold to make it true are. However, the theory has its detractors, who
believe the market overreacts to economic changes, resulting in stocks becoming
overpriced or underpriced, and they have their own historical data to back it up.

• For example, consider the boom (and subsequent bust) of the dot-com bubble in
the late 1990s and early 2000s. Countless technology companies (many of which
had not even turned a profit) were driven up to unreasonable price levels by an
overly bullish market. It was a year or two before the bubble burst, or the market
adjusted itself, which can be seen as evidence that the market is not entirely
efficient—at least, not all of the time.
 CONCLUSION
• Weak form is supported, so technical analysis cannot consistently outperform the
market.

• Semi-strong form is mostly supported , so fundamental analysis cannot consistently

outperform the market.

• Strong form is generally not supported. If you have secret (“insider”) information, you
CAN use it to earn excess returns on a consistent basis.

• Ultimately, most believe that the market is very efficient, though not perfectly
efficient. It is unlikely that any system of analysis could consistently and significantly
beat the market (adjusted for costs and risk) over the long run.
THANK YOU