Question

Stock prices depend on how the economy is doing. Macroeconomic variables reflecting the state of the economy are highly statistically predictable. Thus, stock prices (returns) should be predictable too, but they are NOT. How can you explain this apparent puzzle with the efficient markets hypothesis?

Answer 1

The stock price of a company is affected by large number of economic factors and the macroeconomic factors is just one of those factors but having said that macroeconomic factors is the major factors. Even when we say that economic variables are statistically predictable, we are only able to estimate that with a certain level of accuracy. The stock price can be affected by economic factors, investor perception about the company, its level of leverage, its earnings, its creditworthiness in the market, and how its business model is, how much market share it has. There are so many factors which can affect the stock price and we can not consider all of them with a high level of accuracy even with probability of each event so stock prices are unpredictable. Efficient market hypothesis says that market prices reflect the true intrinsic value of the stock and all the relevant information that can affect the stock price has already been adjusted in the price however it is often seen that in the short-term efficient market hypothesis does not hold and in the long term it might be possible that stock price are closer to its intrinsic value.