The Uses and Concept of Efficient Market Hypothesis Finance Essay

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The Efficient Market Hypothesis is one of the most important and widely disputed propositions in finance and economics(pesaran(2010)). There is no doubt that EMH is a cornerstone of modern finance. Market efficiency is a concept intimately related to the diffusion of information. In retrospect, we see that The efficient market hypothesis is inextricably related to the Random walk theory as Reilly and brown (2005) asserts that the primary work of EMH is based on random walk theory. It is commonly believed in academic circles that the most prominent work done in this regard originates to Bachelier in 1900 (Pesaran 2010). The random walk is used to refer to subsequent price changes which are independent of each other. In other words, tomorrow’sprice change cannot be anticipated by looking at today’s price change Nikolay Angelov(2009). The most notable subsequent works such as Working (1934), Cowles and Jones (1937), Kendall(1953) are based on empirical evidence to support Random walk hypothesis but, hitherto, it lacks theory based model to explain random walk in prices. The gap filled by more general model based on the concept of efficiency of the markets which we know as EMH. This theory was proposed by fama in late 1970s. Since its inception it becomes a subject for constant debate in research community in view of its importance and implications

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Fama paints Efficient market hypothesis in terms of fair game model(Hassan,Abdullah&Shah(2007). A precondition of strong form of EMH is that information and trading costs, the cost of getting prices to reflect information, are always 0(Grossman and Stiglitz(1980)) . A weaker and more sensible version of the efficiency hypothesis says that prices fully reflect information to the point where the marginal benefits of acting on information exceed the marginal costs (Jenson1978)He introduce three versions of EMH namely weak form of efficiency, semi strong form of efficiency and strong form of efficiency A market is weak form efficient if the current stock prices or return series are not predictable from past prices or return information (Fama 1991).The market is semi-strong form efficient if the current security prices fully reflect all publicly available Information and consistent above average return is not possible. Finally, the market is strong form efficient if security prices reflect all private and public information (Hin Yu Chung(2006)). The Random Walk Model is widely used to testify the weak-form Efficient Market Hypothesis. The Random Walk Model (RWM) is the model which assumes that subsequent price changes are sovereign and concludes that changes in future pricesfcantnotlbevforecastedzthroughfhistoricaltpricecfchangesgandgmovements(kashif,Shahid,Sleman,Shah(2010)). This theory gathered wide reputation all over the world as economist as long been fascinated by changes in prices. It initiates a plethora of studies for its underlying significance. While examine the findings of these studies for sake of convenience , we study the findings of studies in developed and emerging countries separately. We have fundamental rationale behind this that In comparative terms, while the Developed markets with well-established institutions are characterized as having high level of liquidity and trading activity, substantial level of market depth and low information asymmetry, on the other hand,the emerging market are seen to exhibit more information asymmetry, thin trading and shallow depth because of their weak institutional infrastructure. (Khaled and Islam (2005)).

Lee (1992) use variance ratio test to examine whether weekly stock returns of the United States and 10 industrialized countries namely: Australia, Belgium, Canada, France, Italy, Japan, Netherlands, Switzerland, United Kingdom, and Germany follow a random walk process for the period 1967-1988. He conclude that the random walk model is still appropriate characterization of weekly return series of for majority of these countries and validates weak form of efficiency in aforesaid countries. Choudhry (1994) explore the stochastic structure of individual stock indices in seven OECD countries: the United States, the United Kingdom,Canada, France, Germany, Japan and Italy. The Augmented Dickey-Fuller and KPSS unit root tests, and Johansen’s co-integration tests was used to test the log of monthly stock indices from the period 1953 to 1989. He finds that stock markets in OECD countries are efficient during the sample period. Al-Loughani and Chappel (1997) examine the validity of the EMH market hypothesis for the United Kingdom stock market using the Lagrange multiplier (LM) serial correlation, Dickey-Fuller unit root and Brock,Dechert and Scheinkman (BDS) non-linear tests. Their finding are consistent with EMH assumptions. Groenewold (1997) examines both weak and semi-strong forms of the EMH for Australia and New Zealand and rejects EMH for said markets. Lima and Tabak (2004) contend that the random walk hypothesis for Hong Kongequity markets is not rejected, but for Singapore markets it is rejected. Solink (1973) examines stocks from eight stock markets of the France, Italy, UK, Germany, Belgium, Neither land, Switzerland, Sweden and USA. The RWM reveal that the variations are slightly more apparent in European stock markets than the USA market counting technical conditions behind it.

Now we examine some studies examine in developing countries scenario . Appiah-Kusi and Menyah (2003) test out the weak-form efficiency of 11African stock markets including Botswana, Egypt, Ghana, Ivory Coast, Kenya,Mauritius, Morocco, Nigeria, South Africa, Swaziland, and Zimbabwe Their results indicate that except the markets in Egypt, Kenya, Mauritius, Morocco, and Zimbabwe, rest of the six markets are arrived consistent with weak form efficient. Using the serial correlation, runs and unit root tests Abeysekera (2001)indentifies that the Colombo Stock Exchange (CSE) in Sri Lanka is weak-form inefficient. Mobarek and Keasey (2002) use the runs and autocorrelation tests to examine the validity of weak-form efficiency for the Dhaka stock market in Bangladesh he says that returns of Dhaka stock market do not follow random Walks. Gilmore and McManus (2003) explore whether the stock markets in Central European countries including Czech Republic, Hungary and Poland. They assert that these three markets are not yet weak-form efficient in functioning. Abrosimova et al. (2005) tested for weak-form efficiency in the Russian stock They end up with conclusion that support weak-form efficiency in the Russian stock market. According to Hassan et al. (2006), markets in Czech Republic, Hungary, Poland and Russia are found to be unpredictable supporting EMH. Abraham et al. (2002) reject the random walk hypothesis for the Saudi Arabia and Bahrain markets.

In research studies on South Asian markets, researchers arrive at mix set of results. As Sharma and Kennedy (1977) and Alam et al. (1999) report that the random walk hypothesis cannot be rejected for stock price changes on the Bombay (India) and Dhaka Stock Exchange (Bangladesh) respectively. Ramachandran (1985), Gupta (1985), Srinivasan (1988), Vaidyanathan and Gali (1994) and Prusty (2007) supports the weak form efficiency of Indian capital market. However, some studies like Kulkarni (1978), Chaudhury (1991), Poshakwale (1996), Pant and Bishnoi (2002), Pandey (2003), Gupta and Basu (2007), Mishra, (2009) and Mishra and Pradhan, (2009) do not support the existence of weak form efficiency in Indian capital market. Regarding to the scenario of Pakistan (Hasan, Shah and Abdullah (2007)) examine the weak-form market efficiency of Karachi Stock Exchange (KSE). The results reveal that prices behavior is not supporting random walks and hence these are not weak-form efficient. According to Kashif and Yasir (2005) there exist evidence of weak form of efficiency in Karachi stock exchange. Abeysekera (2001) indicates that the Colombo Stock Exchange (CSE) in Sri Lanka is weak-form inefficient. Cooray, Arusha.

Wickremasinghe, Guneratne(2007) support weak form efficiency for all countries in south asian region including pakistan, india ,Srilanka and Bangladesh. this study mainly seeks evidence on whether the Bangladesh stock market return series is independent or follows the random walk model. Hence, it is an interesting empirical question whether and to what extent a less developed market like the Dhaka stock market is efficient and what return generation factors drive the market.

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The Uses And Concept Of Efficient Market Hypothesis Finance Essay. (2017, Jun 26). Retrieved January 29, 2023 , from

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