Question

The efficient markets hypothesis (EMH), known as the Random Walk Theory, is the proposition that current stock prices fully reflect available information about the value of the firm, and there is no way to earn excess profits, by using this information. However, the pandemic covid-19 might challenge this theory. In relation to that, you are asked to test whether the different forms of EMH (weak, semi strong and strong forms) on the stock exchange of Mauritius.

Test the semi strong form of EMH using the profit difference between certain stock and the benchmark index pre and during covid-19. Provide analysis of your results. You are required to provide screenshots of your tests and results.

Please explain to me what data should i used and what tests should be carried out in details.

Answer 1

What Is the Random Walk Theory?

Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other. Therefore, it assumes the past movement or trend of a stock price or market cannot be used to predict its future movement. In short, random walk theory proclaims that stocks take a random and unpredictable path that makes all methods of predicting stock prices futile in the long run.

Efficient Markets are Random

The random walk theory raised many eyebrows in 1973 when author Burton Malkiel coined the term in his book "A Random Walk Down Wall Street." The book popularized the efficient market hypothesis (EMH), an earlier theory posed by University of Chicago professor William Sharp. The efficient market hypothesis states that stock prices fully reflect all available information and expectations, so current prices are the best approximation of a company’s intrinsic value. This would preclude anyone from exploiting mispriced stocks consistently because price movements are mostly random and driven by unforeseen events.

Sharp and Malkiel concluded that, due to the short-term randomness of returns, investors would be better off investing in a passively managed, well-diversified fund. A controversial aspect of Malkiel’s book theorized that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts."

Example:

Random Walk Theory in Action

The most well-known practical example of random walk theory occurred in the Wall Street Journal sought to test Malkiel's theory by creating the annual Wall Street Journal Dartboard Contest, pitting professional investors against darts for stock-picking supremacy. Wall Street Journal staff members played the role of the dart-throwing monkeys.

After 100 contests, the Wall Street Journal presented the results, which showed the experts won 61 of the contests and the dart throwers won 39. However, the experts were only able to beat the Dow Jones Industrial Average (DJIA) in 51 contests. Malkiel commented that the experts' picks benefited from the publicity jump in the price of a stock that tends to occur when stock experts make a recommendation. Passive management proponents contend that, because the experts could only beat the market half the time, investors would be better off investing in a passive fund that charges far lower management fees.

Test the semi strong form of EMH using the profit difference between certain stock and the benchmark index pre and during covid-19. Provide analysis of your results.

As per the Above example it would be found that EMH Which can be same identified into the Cpvid-19 time,

The Three Main Variants of Efficient Markets Hypothesis

• Weak Form Efficiency: The basis of "weak form efficiency" is, as the qualifying phrase to all investors by advisers always suggests: "past performance is no guarantee of future results." In other words, future prices cannot be predicted merely by reviewing past prices. So that excess returns - or improved returns - cannot be made over time basing investment strategy on historical share prices or other data.

• Semi-Strong Form Efficiency: The basis of "semi-strong form efficiency" is that share prices adjust to publicly available new information quickly, and in an unbiased manner, so that no excess returns can be made trading on that information. A test of this is reviewing consistent upward or downward price adjustments after an initial piece of news hits. The movement and direction is believed to indicate if investors interpreted the news in a biased way, which is therefore "inefficient," or unbiased, which is "efficient."

• Strong Form Efficiency: In "strong-form efficiency," all share prices reflect the entirety of available information, both public and private, meaning no individual can make excess returns, or "beat the market." This form of market efficiency isn't possible where legal barriers exist to private information becoming public. An example of legal barriers to private information becoming public is insider trading laws. The only way in such an environment for strong-form efficiency is if barriers to private information becoming public are ignored, so that prices reflect private as well as public information.