Question

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Question C2

Q2a. Describe Efficient Market Hypothesis (EMH).

Q2b. Ifa financial analyst could consistently identify underpriced stock by technical analysis (i.e. by analyzing the historical prices of stock), does it imply that EMH is wrong? Justify your answer.

Answer 1

2.

A.

Efficient market hypothesis is a theory that proposes that securities or assets already absorb the information available in the market and there is no possibility to beat the market by consistently identifying and investing in underpriced stock and selling overpriced stocks. It has three forms.

First form of EMH is weak form EMH where stock prices absorb the past historical data and reflect that in current prices. It means that on the basis of past price data, market is efficient.

Second form of EMH is semi strong form EMH, where the stock prices absorb all the public information available along with the historical price.

Third form of EMH is strong form EMH, where the stock prices absorb all the private information as well as public information along with the price related historical data. It makes impossible to achieve extraordinary returns or gain.

B.

It implies that past historical price data and its hidden information is not being observed by the market. There can also be one  reason that trading may not be regular or volume of trading is considerably lower.  It is the reason that weak form efficiency is not being achieved by the market.

For a weak form efficiency to exist, it is important that stocks should absorb the information via past historical data that is not happening in the market. So, weak form EMH is not working on the basis of a given evidence.