Tuesday, December 9, 2008

(26).---EFFICIENT CAPITAL MARKET & EMH ( Efficient Market Hypothesis ).

Efficient Market & EMH.

In an efficient capital market, security prices adjust rapidly to the infusion of new information. And therefore current security prices fully reflect all available information. This is to as an informationally efficient market.
Why Capital Markets Should Be Efficient ?

Following set of assumptions imply an efficient capital market:
  1. A large no of profit maximizing participants analyze & value securities, each independent of others.
  2. New information regarding securities comes to the market in a random fashion, & timing of one announcement is generally independent of others.
  3. Profit maximizing investors adjust security prices rapidly to reflect the effect of new information.
  4. Because security prices adjust to all new information, these security prices should reflect all information that is publicly available at any point in time.

Efficient Market Hypothesis ( EMH ).
The three (3) forms of efficient market hypotheses are:
  1. Weak for EMH.-----The week for EMH assumes that current stock prices fully reflect all security market information. Including the historical sequence of prices rates of return trading volume data & other market generated information. This hypothesis implies that past rates of return & other market data have no relationship with future rates of return.
  2. Semi Strong Form EMH.-----This assets that security prices adjust rapidly to the release of all public information; that is, current security prices fully reflect all public information, The semi strong for EMH encompasses the weak form hypothesis, because all the market information considered by the weak form hypothesis, such as stock prices, rates of return , trading volume is public. Public information also includes all non-market information such as earnings & dividend announcements price earnings ratio, dividend yields,book value etc. This hypothesis implies that investors who base their decisions on any important new information after it is public should not derive above average risk adjusted profits from their transactions, because the security price already reflects all such new public information.
  3. Strong Form EMH.-----The strong form EMH contends that stock prices fully reflect all information public & private sources. This means that no group of investors has monopolistic access to information relevant to the information of prices.Therefore this hypothesis contends that no group of investors should be able to consistently drive above avarage risk adjusted rates of return.This hypothesis encompasses both the wake form & semi strong form EMH.Further , the strong form EMH extends the assumption of efficient markets, in which prices adjust rapidly to the release of new public information to assume perfect markets , in which all information is cost free & available to everyone at the sometime.

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