THE EFFICIENT MARKETS HYPOTHESIS (EMH) In finance, the efficient market hypothesis (EMH) asserts that financial markets

are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects. Professor Eugene Fama at the University of Chicago Graduate School of Business developed EMH as an academic concept of study through his published Ph.D. thesis in the early 1960s at the same school. The efficient market hypothesis states that it is not possible to consistently outperform the market by using any information that the market already knows, except through luck. Information or news in the EMH is defined as anything that may affect prices that is unknowable in the present and thus appears randomly in the future. ASSUMPTIONS Beyond the normal utility maximizing agents, the efficient market hypothesis requires that agents have rational expectations; that on average the population is correct (even if no one person is) and whenever new relevant information appears, the agents update their expectations appropriately. Note that it is not required that the agents be rational (which is different from rational expectations; rational agents act coldly and achieve what they set out to do). EMH allows that when faced with new information, some investors may overreact and some may underreact. All that is required by the EMH is that investors' reactions be random and follow a normal distribution pattern so that the net effect on market prices cannot be reliably exploited to make an abnormal profit, especially when considering transaction costs (including commissions and spreads). Thus, any one person can be wrong about the market indeed, everyone can be but the market as a whole is always right. There are three common forms in which the efficient market hypothesis is commonly stated weak form efficiency , semi-strong form efficiency and strong form efficiency , each of which have different implications for how markets work. WEAK-FORM EFFICIENCY

No excess returns can be earned by using investment strategies based on historical share prices or other financial data. Weak-form efficiency implies that Technical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysis may still provide excess returns. In a weak-form efficient market current share prices are the best, unbiased, estimate of the value of the security. Theoretical in nature, weak form efficiency advocates assert that fundamental analysis can be used to identify stocks that are undervalued and overvalued. Therefore, keen investors looking for profitable companies can earn profits by researching financial statements.

SEMI-STRONG FORM EFFICIENCY

Share prices adjust within an arbitrarily small but finite amount of time and in an unbiased fashion to publicly available new information, so that no excess returns can be earned by trading on that information. Semi-strong form efficiency implies that Fundamental analysis techniques will not be able to reliably produce excess returns. To test for semi-strong form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner.

STRONG-FORM EFFICIENCY

Share prices reflect all information and no one can earn excess returns. If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. Studies on the U.S. stock market have shown that people do trade on inside information. To test for strong form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. Even if some money managers are consistently observed to beat the market, no refutation even of strongform efficiency follows: with tens of thousands of fund managers worldwide, even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers.

AN ALTERNATIVE THEORY: BEHAVIORAL FINANCE Opponents of the EMH sometimes cite examples of market movements that seem inexplicable in terms of conventional theories of stock price determination, for example the stock market crash of October 1987 where most stock exchanges crashed at the same time. It is virtually impossible to explain the scale of those market falls by reference to any news event at the time. The explanation may lie either in the mechanics of the exchanges (e.g. no safety nets to discontinue trading initiated by program sellers) or the peculiarities of human nature. Behavioural psychology approaches to stock market trading are among some of the more promising alternatives to EMH (and some investment strategies seek to exploit exactly such inefficiencies). A growing field of research called behavioral finance studies how cognitive or emotional biases, which are individual or collective, create anomalies in market prices and returns that may be inexplicable via EMH alone. However, how and if individual biases manifest inefficiencies in market-wide prices is still an open question. Indeed, the Nobel Laureate co-founder of the programme - Daniel Kahneman - announced his skepticism of resultant inefficiencies: "They're [investors] just not going to do it [beat the market]. It's just not going to happen." [3]

Ironically, the behaviorial finance programme can also be used to tangentially support the EMH - or rather it can explain the skepticism drawn by EMH - in that it helps to explain the human tendency to find and exploit patterns in data even where none exist. Some relevant examples of the Cognitive biases highlighted by the programme are: the Hindsight Bias; the Clustering illusion; the Overconfidence effect; the Observer-expectancy effect; the Gambler's fallacy; and the Illusion of control. 2.2) The implications of the EMH for optimal investment strategies The EMH has implied that no one can outperform the market either with security selection or with market timing. Thus, it carries huge negative implications for many investment strategies. Generally, the impact of EMH can be viewed from two different perspectives: i) Investors perspective: Technical analysis uses past patterns of price and the volume of trading as the basis for predicting future prices. The random-walk evidence suggests that prices of securities are affected by news. Favourable news will push up the price and vice versa. It is therefore appropriate to question the value of technical analysis as a means of choosing security investments. Fundamentals analysis involves using market information to determine the intrinsic value of securities in order to identify those securities that are undervalued. However semi strong form market efficiency suggests that fundamentals analysis cannot be used to outperform the market. In an efficient market, equity research and valuation would be a costly task that provided no benefits. The odds of finding an undervalued stock should be random (50/50). Most of the time, the benefits from information collection and equity research would not cover the costs of doing the research. For optimal investment strategies, investors are suggested should follow a passive investment strategy, which makes no attempt to beat the market. Investors should not select securities randomly according to their risk aversion or the tax positions. This dose not means that there is no portfolio management. In an efficient market, it would be superior strategy to have a randomly diversifying across securities, carrying little or no information cost and minimal execution costs in order to optimise the returns. There would be no value added by portfolio managers and investment strategists. An inflexible buy-and-hold policy is not optimal for matching the investor's desired risk level. In addition, the portfolio manager must choose a portfolio that is geared toward the time horizon and risks profile of the investor. ii) Financial managers perspective Managers need to keep in mind that markets would under react or over react to information, the company's share price will reflect the information about their announcements (information). The historical share price record can be used as a measure of company performance and management bear responsibility for it. When share are under priced, managers should avoid issuing new shares. This will only worsen the situation. In normal circumstances, market efficiency theory provides useful insight into price behaviour. Generally, it can be concluded that investors should only expect a normal rate of return while company should expect to receive the fair value for the securities they issue.

Random walk hypothesis The random walk hypothesis may be derived from the weak-form efficient markets hypothesis, which is based on the assumption that market participants take full account of any information contained in past price movements (but not necessarily other public information). In his book A Random Walk Down Wall Street, Princeton economist Burton Malkiel said that technical forecasting tools such as pattern analysis must ultimately be self-defeating: "The problem is that once such a regularity is known to market participants, people will act in such a way that prevents it from happening in the future."[50] In the late 1980s, professors Andrew Lo and Craig McKinlay published a paper which cast doubt on the random walk hypothesis. In a 1999 response to Malkiel, Lo and McKinlay collected empirical papers that questioned the hypothesis' applicability[51] that suggested a non-random and possibly predictive component to stock price movement, though they were careful to point out that rejecting random walk does not necessarily invalidate EMH, which is an entirely separate concept from RWH. In a 2000 paper, Andrew Lo back-analyzed data from U.S. from 1962 to 1996 and found that "several technical indicators do provide incremental information and may have some practical value".[44] Technicians say[who?] that the EMH and random walk theories both ignore the realities of markets, in that participants are not completely rational and that current price moves are not independent of previous moves.[21][52]