Question

Analyze the capital market scenario of the following countries and indicate (mention) what form of market efficiency is observed in these capital markets under Efficient Market Hypothesis (EMH)?

• Country A : Prices already reflect all PAST information.
• Country B:   Prices not only reflect the history of prices but all publicly available information.
• Country C:   Prices reflect all available information, regardless of them being public or private.

Identify the difference between technical and fundamental analysis and Efficient Market Hypothesis (EMH) implication for each type of analysis

Answer 1

Country A is weak form of market efficiency. In a weak form of market efficiency, the stocks reflect all the past available information, the stock prices follow a random walk and no amount of technical analysis can help predict the stock prices in the future.

Country B is semi strong form. In a semi strong form, the stock prices reflect all the past and the available public information but not the insider information. No fundamental analysis can help us select which stocks to buy as all the stocks completely reflect all the available information and so stocks prices are correctly/ fairly priced.

Country C : is the strong form of market efficiency : in the strong form of market efficiency, the stocks prices not only reflect the available public information but also the private/insider information.

The technical analysis uses graphs and charts to help predict the stock prices. As per the technical analysis, the stocks which follow a certain pattern in the past , will continue the same pattern in the future. So, on the basis of the study, the investors can select which stocks to buy. The EMH believes that as stocks prices completely reflects all the available information , the technical analysis is redundant.

Fundamental analysis : uses valuation models to determine which stocks are undervalued and which stocks are overvalued. The efficient market hypothsis believes that as stocks prices are fairly priced, the fundamental analsysis does not help to identify stocks which the investor cna buy and so it is redundant.