Question

describe efficient market hypothesis and weaknesses of the theory? 20 marks question..

Answer 1

The efficient market hypothesis is the theory that states that the market forces are such that they will bring the market into equilibrium. The investors in the market always try to beat the market so that they can make more profits. But the market forces ensure that there is no such situation created where one section of investors get more benefit than the others. The market forces ensure that there is a level playing field in the market. All the investors in the market should be able to get the same kind of opportunity. The market forces correct itself so that no body can take the undue advantage of the situation. The hypothesis also states that the asset prices reflect all the information that is available in the market. There will not be a situation where the investors will be able to make more money due to arbitrage.

Some of the major weaknesses of the Efficient Market Hypothesis is that it does not take into account the transactional costs that will be incurred by the investors. The volatility of the market is also not considered and the investors may also fall prey to information bias as well as representative bias. Sometimes the investors may also be over confident about the performance of certain stocks and may over react to the information available in the market. The EMH does not take these things into consideration.