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In: Finance

Your friend is a hedge fund manager. He tells you that he has earned 6% returns...

Your friend is a hedge fund manager. He tells you that he has earned 6% returns on average above the S&P 500 return over the past five years, so he doesn’t believe in efficient market. Do you agree with him? Explain.

Solutions

Expert Solution

Efficient market hypothesis:

In an strong efficient market it must it is impossible to beat the market. As all the information is already reflected in the stock price.

They are 3 levels of Market efficiency:
1. Strong efficiency: Insider information, fundamental analysis and technical analysis are unless in such a market.
2. Semi- Strong: fundamental analysis and technical analysis are unless in such a market.
3. Weak: technical analysis is unless in such a market.  

In practical life: it's very difficult to obtain strong efficiency markets.

Currently, markets are not 100% efficient ( strong efficiency markets).

Most of the markets currently lie between Weak and Semi- Strong.
Some emerging markets are below weak efficiency. That is technical analysis and past trend affect the stock price moments.

We can only benefit from Insider Information in Semi- Strong efficiency markets.

So yes I do agree with the friend that markets are not efficient.

The hedge fund manager friend must have taken benefits of Insider information or fundamental analysis or technical analysis.

His did it for 5 years. It is reasonable amount of time to consistency beat the market by 6% .
Which shows that markets are not efficient.

jeff jeffy answered 1 year ago
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