1. Discuss the rationale for expecting an efficient capital market. What factor

Question

1. Discuss the rationale for expecting an efficient capital market. What factor would you look for to differentiate the market efficiency for two alternative stocks? Answer: All information is publicly available to the market players and no player in the market will have information quick and more easily than the others.

2. For many of the EMH tests, it is really a test of a “joint hypothesis’. Discuss what is meant by this concept. What are the joint hypotheses being tested? First test is EMH

3. Briefly discuss the implications of the efficient market hypothesis for investment policy as it applies to:

i. Technical analysis, and

ii. Fundamental analysis

4. Explain the concept of behavioural finance and discuss how it relates to the efficient market hypothesis

Explanation / Answer

1. Discuss the rationale for expecting an efficient capital market. What factor would you look for to differentiate the market efficiency for two alternative stocks?

The rationale for expecting an efficient capital market are as follows-

1. There are a large number of independent, profit-maximizing investors engaged in the analysis and valuation of securities.

2. A second assumption is that the new information comes to the market randomly

3.The third assumption is that the numerous profit-maximizing investors will adjust security prices rapidly to reflect this new information. Thus, price changes would be independent and random

4. Because stock prices reflect all information, one would expect prevailing prices to reflect “true” current value.

Capital markets as a whole are generally expected to be efficient, but the markets for some securities might not be as efficient as others. Note that markets are expected to be efficient because there are a large number of investors who receive new information and analyze its effect on security values. If there is a difference in the number of analysts following a stock and the volume of trading, one could conceive of differences in the efficiency of the markets.For example, new information regarding actively traded stocks such as IBM and Apple is well publicized and numerous analysts evaluate the effect. Therefore, one should expect the prices for these stocks to adjust rapidly and fully reflect the new information. On the other hand,new information regarding a stock with a small number of stockholders and low trading volume will not be as much publicized and few analysts follow such firms. Therefore, prices may not adjust as rapidly to new information and the possibility of finding a temporarily undervalued stock are also greater.

Size of the firms is another factor to differentiate the efficiency of stocks. Specifically, it is believed that the markets for stocks of small firms are less efficient than that of the larger firms.

Note- As per Chegg answering guidelines we are only allowed to answer 1 question per post. Kindly post the remaining questions to get their answer. Thanks.

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.