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Introduction
This report is focus on the capital market efficiency and will make a general overview of the capital market efficiency. For this report, it divided into the definitions of capital market; explaining what efficiency is; information and understanding of the importance of random walk and analysis why take it to the stock market; definition of stock market and discuss is the stock efficiency or not, and the last part is about the efficient market hypothesis.
Random walk
What is random walk? Random walk refers to the stock price changes are random and unpredictable. Usually this randomness is thought to imply that the stock market is a non rational, but on the contrary, the random change of stock price shows the market is normal operation or is effective. (baike, 2012) As a drunk peoples irregular walking, maybe after walking several steps he would return to the starting point, but this probability is very small.
(baike, 2012) The chart above, its vertical axis is the location, 0 point is the bar, and the horizontal axis is the steps, the drunken people start from 0 point and he can go to anywhere, this different color curves representing his route, and this chart shows random walk of the drunken people. Take the random walk to the stock market, it means stock price movements are random and unpredictable. The reasons may be are investors whim, natural disasters, company closures and other unpredictable news events and so on. Stock abides by a random walk if the movement of stock prices from day to day does not reflect any pattern.
Why does the random walk occur? A random walk occurs because the share price at any one time reflects all available information and it will only change if new information arises. Successive price changes will be independent and prices follow a random walk because the next piece of news will be
independent of the last piece of news. Shareholders are never sure whether the next item of relevant information is going to be good or bad. (Arnold.G, 2008:568)
(Arnold.G, 2008:569)
Through the chart above we can see in stock market how an efficient market will not allowed unusual profits. Before time A, the share price has shown a cyclical pattern, however, this chart reflecting a desired that over the next six months the share price will raise alone the dotted line. Once this expects by market participants know, people will naturally choose to buy. And this behaviour will lead to the share price to rise and violate the fairness of stock. The stock fairness demand public information resources, it makes an investor have no more useful information to overcome other investors. In the case of complete information disclosure, the share price curve should tend to random walk.
shares issued market. Efficiency means that the price of securities to fully, timely and accurately reflect the market-related information, investors cannot use available information to adjust the investment strategy to get the long-term excess returns. However, is the stock market efficiency? It is based on efficient market hypothesis, this hypothesis holds that history does not provide any help to predict stock prices, this means that research a stock chart, and even read the relevant Financial Times, they are unable to judge prices trend on tomorrow or next year. It takes rational expectation as the assumption. As long as all related with the stock information rapidly and completely reflected in asset prices, then the stock market is efficiency.
This definition indicates that market participants use all relevant information on the basis of accurate values of securities to produce security prices. Connecting this definition there are two basis concerns. Firstly, Is new information fully absorbed and instantaneously effect in a share price? Secondly, either this information is relevant or irrelevant? She distinguished between three types of efficiency; weak, semi-strong, and strong-form efficiency for testing market efficiency. Weak Form Efficiency is a market in which the current price of the market reflects all information fully and instantly considering the past history of security prices. Semi-strong Form Efficiency is said to be that market in which publically available information instantly and fully reflect the current prices of securities. Strong form Efficiency is explained as that market in which both public and private information instantly and fully reflect the current prices of securities.
Evidence
As empirical researchers has concerned with whether prices fully reflects to subsets of all information. Mostly results comes from Random Walk literature. Attention was focused to se-strong form test considering the speed of price adjustment and publically available information because the extensive test support the efficiency hypothesis. A. Weak Form Tests of the Efficient Markets Model In Random Walks an in Firm Games, the empirical on efficient markets will be considered in the context of general expected returns and evidence directly bears on sub martingale expected return model. in previous literature, the efficient markets model was praised more to random walk model. Mostly authors were concerned with firm game model and empirical evidence in random walk literature is interoperated as 'firm-game' models. In terms of Market Efficiency in the Random Walk Literature we discussed earlier that the implications of 'fair-game' models has impossibility on different trading system. some Random Walks literatures are reflecting the testing of profitability and other literature has concerns with serial covariance of returns. Other Tests of Independence in the Random Walk Literature is probably the best random Walk model as compare to general expected returns model is designing a detailed specification oriented economic environment. Far-Game expected returns mode is the model of equilibrium in which Random Walks helps in environmental conditions in term of distribution of one period returns with time. At this level Random Walk are expected to violate the pure independence but on the other side that benchmark provided by random walk model has effect of insights in the nature of market environment. While discussing the Distributional evidence researchers assumes that the price changes within the transaction is independent. Central limit Theorem takes us to expect that price changes will have normal on Gaussian distribution if the transaction is fairly spread on time. B. Tests of Martingale Models of the Semi-strong Form Generally Semi-strong form test of efficient markets model are more concerned with current prices obviously as a public available information. Every single test is concerned within the adjustment of share prices to single kind of information. Thus each test bring the idea that accumulating these evidence , the validity of the model will be established. Firstly in splits and the adjustments of stock prices to new information the result of a stock split is the multiplication of stock per shareholder without effecting the claims to real state and splits are not source of information. According to the researchers splits are associated with more fundamentally important information. the purpose is to ensure security returns on splits dates to see if they are unusual and calculating the relationship between splits and other variables.
C. Strong Form Tests of the Efficient Markets Models Strong form of the efficient markets model shows interest mostly in those circumstances in which all relevant information is fully effected in the prices with no effected trading profits because they have monopolistic access of information. we cannot take this model as an ideal in terms of reality reasoning that in previous discussion already indicate contradictory evidence. NYSE uses this approach to generate monopoly profits and even managers have monopolistic information about their companies. According to theoretical frame the basic aim is to determine whether managers have adequate access to generate abnormal expected returns and other secondly some funds are better to uncover that information than others. Since these funds produce higher , the special information should be kept insight from public available information. thus this test is not strictly strong form of test for efficient markets model.
Conclusion
Now concluding the whole discussion we had generally the theory is the reflection of efficient markets and its is concerned on prices at any point in time fully reflect all relevant information. As we know that our empirical literature is explicitly based on condition of markets equilibrium in terms of expected returns. As our work id divided into three categories, Strong for test focused on individuals inventions or if it is a group than they have monopoly in accessing the information for price formation. On the other side as we know that Semi-Strong uses all obviously publically available information. And at the end last but not the least in Weak form tests the information which is historical on return sequences. Key Points: The literature on market efficiency suggest that weak market efficiency holds The evidence in support of Semi-strong market efficiency is quite strong (semistrong), but not as solid as weak form efficiency The evidence shows that share prices react to new information speedily as predicted by theory Finally the evidence for strong-form efficiency is relatively weak.
References
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