Efficient market is closely related to (the absence of) arbitrage. It might be defined as simply an ideal market without arbitrage, but there is much more to it than that. Let us first ask what actually causes price to change. The share price of a company may change due to its new earnings report, due to new prognosis of the company performance, or due to a new outlook for the industry trend. Macroeconomic and political events, or simply gossip about a company’s management, can also affect the stock price. All these events imply that new information becomes available to markets. The Efficient Market Theory states that financial markets are efficient because they instantly reflect all new relevant information in asset prices. Efficient Market Hypothesis (EMH) proposes the way to evaluate market efficiency. For example, an investor in an efficient market should not expect earnings above the market return while using technical analysis or fundamental Three forms of EMH are discerned in modern economic literature. In the ‘‘weak’’ form of EMH, current prices reflect all information on past prices. Then the technical analysis seems to be helpless. In the ‘‘strong’’ form, prices instantly reflect not only public but also private (insider) information. This implies that the fundamental analysis (which is what the investment analysts do) is not useful either. The compromise between the strong and weak forms yields the ‘‘semistrong’’ form of EMH according to which prices reflect all publicly available information and the investment analysts play important role Two notions are important for EMH. The first notion is the random walk, which will be formally defined in Section 5.1. In short, market prices follow the random walk if their variations are random and independent. Another notion is rational investors who immediately incorporate new information into fair prices. The evolution of the EMH paradigm, starting with Bachelier’s pioneering work on random price behavior back in 1900 to the formal definition of EMH by Fama in 1965 to the rigorous statistical analysis by Lo and MacKinlay in the late 1980s, is well publicized [9–13]. If prices follow the random walk, this is the sufficient condition for EMH. However, as we shall discuss further, the pragmatic notion of market efficiency does not necessarily require prices to follow the random Criticism ofEMHhas been conducted along two avenues. First, the thorough theoretical analysis has resulted in rejection of the random walk hypothesis for the weekly U.S. market returns during 1962–1986 [12]. Interestingly, similar analysis for the period of 1986–1996 shows that the returns conform more closely to the random walk. As the authors of this research, Lo and MacKinlay, suggest, one possible reason for this trend is that several investment firms had implemented statistical arbitrage trading strategies5 based on the market inefficiencies that were revealed in early research. Execution of these strategies could possibly eliminate some of the arbitrage opportunities. Another reason for questioning EMH is that the notions of ‘‘fair price’’ and ‘‘rational investors’’ do not stand criticism in the light of the financial market booms and crashes. The ‘‘irrational exuberance’’ in 1999–2000 can hardly be attributed to rational behavior [10]. In fact, empirical research in the new field ‘‘behavioral finance’’ demonstrates that investor behavior often differs from rationality [14, 15]. Overconfidence, indecisiveness, overreaction, and a willingness to gamble are among the psychological traits that do not fit rational behavior. A widely popularized example of irrational human behavior was described by Kahneman and Tversky [16]. While conducting experiments with volunteers, they asked participants to make choices in two different situations. First, participants with $1000 were given a choice between: (a) gambling with a 50% chance of gaining $1000 and a 50% chance of gaining nothing, or (b) a sure gain of $500. In the second situation, participants with $2000 were given a choice between: (a) a 50% chance of losing $1000 and a 50% of losing nothing, and (b) a sure loss of $500. Thus, the option (b) in both situations guaranteed a gain of $1500. Yet, the majority of participants chose option (b) in the first situation and option (a) in the second one. Hence, participants preferred sure yet smaller gains but were willing to gamble in order to avoid sure loss. Perhaps Keynes’ explanation that ‘‘animal spirits’’ govern investor behavior is an exaggeration. Yet investors cannot be reduced to completely rational machines either. Moreover, actions of different investors, while seemingly rational, may significantly vary. In part, this may be caused by different perceptions of market events and trends (heterogeneous beliefs). In addition, investors may have different resources for acquiring and processing new information. As a result, the notion of so-called bounded rationality has become popular in modern economic literature (see also Section 12.2). Still the advocates of EMH do not give up. Malkiel offers the following argument in the section ‘‘What do wemean by saying markets are efficient’’ of his book ‘‘A Random Walk down Wall Street’’ [9]: ‘‘No one person or institution has yet to provide a long-term, consistent record of finding risk-adjusted individual stock trading opportunities, particularly if they pay taxes and incur transactions costs.’’ Thus, polemics on EMH changes the discussion from whether prices follow the random walk to the practical ability to consistently ‘‘beat the market.’’ Whatever experts say, the search of ideas yielding excess returns never ends. In terms of the quantification level, three main directions in the investment strategies may be discerned. First, there are qualitative receipts such as ‘‘Dogs of the Dow’’ (buying 10 stocks of the Dow Jones Industrial Average with highest dividend yield), ‘‘January Effect’’ (stock returns are particularly high during the first two January weeks), and others. These ideas are arguably not a reliable profit Then there are relatively simple patterns of technical analysis, such as ‘‘channel,’’ ‘‘head and shoulders,’’ and so on (see, e.g., [7]). There has been ongoing academic discussion on whether technical analysis is able to yield persistent excess returns (see, e.g., [17–19] and references therein). Finally, there are trading strategies based on sophisticated statistical arbitrage. While several trading firms that employ these strategies have proven to be profitable in some periods, little is known about persistent efficiency of their proprietary strategies. Recent trends indicate that some statistical arbitrage opportunities may be fading [20]. Nevertheless, one may expect that modern, extremely volatile markets will always provide new occasions for aggressive arbitrageurs.
Emh stock price
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