Question

The concept of “efficient market hypothesis” has attracted a lot of debate and controversy in modern finance. As a student of finance, what critical issues would you say you have learnt about market efficiency using capital market history as your reference point?

Answer 1

The efficient market hypothesis represents the foundation of the modern financial theories from derivatives valuation to capital assets pricing. Practitioners and academics are aware that most of the markets are not efficient and so have developed alternative avenus. In the context of securities fraud and more broadly speaking of crime of financial markets, the efficiency market hypothesis is often used as an argument in courts or in related litigation cases. The rich panel of tests used for assessing market efficiency is a necessary step in studying securities-related crime, but cannot alone determine whether an issue exists or not.

The artificial inflation of securities prices shares common features with bubble formation, even if the mechanisms are different. Therefore, tests for bubble detection can be used successfully for some specific cases of pump and dump or microcap stocks fraud.