Essays on Is Equity Market Efficient Literature review

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The paper "Is Equity Market Efficient" is a great example of a literature review on macro and microeconomics. The efficient market hypothesis has elicited mixed reactions from social scientists and economic-financial researchers. Since its emergence around the 1960’ s efficient market hypothesis maintains that the available information in the stock market is fully reflected in prices. While this is one side of the argument, researches on what constitutes the stock market and prices continue to evolve. This essay, therefore, builds on these hypotheses to discuss the available literature for and against EMH; giving anomalies involved in the hypotheses. Based on researches reviewed, there seems to be a consensus that an efficient market hypothesis has no common definition that binds (Worthington and Higgs 2004; Andrew 2007).

In as much, definitions available have been made depending on the context and subject matter. On the one hand, Worthington and Higgs (2004) view the concept as the ability of the security prices in the market to instantly adjust to the new market information. On the other hand, the concept is understood to be a situation where stock prices are accurate and reflect the information available in the market (Fama, 1970 as cited in Andrew, 2007).

Contemporary researchers, however, delink the aspect of the stock market in their definition by looking at the concept as a whole. Citing recent works, Jeff et al (2010) encompass the concept of market signals in defining market efficiency. While agreeing with other definitions, they add that market signals and feasibility help understand market efficiency since it is only through the two concepts that equity prices will signals market conditions. 2.0Arguments for markets efficiencies Just like its definition, arguments regarding market efficiencies are equally multifaceted.

In so speaking, these arguments have not gone without criticisms. The first criticism that has since formed the basis of other arguments regards the theory of price and time (Samuelsion, 1978 as cited by Andrew, 2007). This theory posits that the price of stock fully reflects information that is fundamental to the investors. As a matter of fact, thought widely documented as a theory, it continues to be widely considered as one of the key pillars used to support the EMH.

To underscore the statement, Bodie et al. (2008) argued that an efficient market should be able to reflect all the available information in the market. What Bodie et al try to bring forth is that more often than not, getting new information on the stock market has proven to be tricky. There is an exception to this though. According to Andrew (2007), one is still able to predict the movement of stock prices and the profit especially when the information is not directly included in stock price and players in the same stock market are not able to do so. How does the theory of price and time link with the random walk hypothesis?

First, it is distinguishable that the random walk hypothesis gets much support from the protagonists of EMH. Secondly, the theory of price and time and random walk hypothesis circles around market efficiency. Recent research that has tried to integrate the two theories with a view to showing market efficiency is Burton and Malkiel (2003). This research uses historical data to support the EMH and concludes that stock prices reflect market information through its prices at the right time.

Such a conclusion brings one important factor; that when stock prices reflect market information through its prices at the right time equity markets are perfected.

References

Andrew W. Lo (2007) efficient markets hypothesis The New Palgrave: A Dictionary of Economics, Second Edition,. New York: Palgrave McMillan.

Basu, S (1999). “The Relationship between Earnings’ Yield, Market Value and the

Returns for NYSE Common Stocks: Further Evidence.” Journal of Financial Economics. June, 12:1, pp. 129–56.

Bodie, Werner, and Richard T. (2008). “Financial Decision-Making in Markets and Firms: A Behavioral Perspective,” in Handbook OR & MS, Volume 9. R. Jarrow et al., eds. New

York: Elsevier Science, Chapter 13.

Burton G. Malkiel (2003) Critics of EMH: Perspectives of Economic Journal—Volume 17, Number 1—Winter 2003—Pages 59 – 82

Jeff Castera, Robert Litzenberger, Richard Gorelick, Yogesh Dwivedi RGM Advisors, ( 2010) Market Efficiency and Microstructure Evolution in U.S. Equity Markets: A High- Frequency Perspective

Worthington K and Higgs J. (2004). The Incredible January Effect. Homewood: Dow Jones- Irwin.

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