Efficient Market Hypothesis & Behavioural Finance

Question 1

What is the Efficient Market Hypothesis?

Answer 1

States that in a fully efficient financial market, prices always reflect the relevant info available to investors.

Question 2

What are the Theoretical Foundations of EMH?

Answer 2

Rationality -
Investors value securities rationally without systematic errors.

Independent deviations from rationality -
Trades of securities are random, cancelling each other out without affecting price.

Arbitrage -
Irrational investors met by rational arbitrageurs who eliminate their influence on price.

Question 3

What are the Different Types of EMH?

Answer 3

Weak Form Efficiency
Semi-Strong Form Efficiency
Strong Form Efficiency

Question 4

What is the Definition of Weak Form Efficiency?

Answer 4

All past market prices & volume data are fully reflected in CA prices.

Question 5

What is the Implication of Weak From Efficiency?

Answer 5

Technical Analysis (using past price patterns to predict future prices) cannot consistently yield excess returns.

Question 6

What is the Rationale behind Weak From Efficiency?

Answer 6

Past rates of return and other past market data should have no relationship with future rates of return.

Question 7

What is the Definition of Semi-Strong Form Efficiency?

Answer 7

All publicly available info is fully reflected in current prices.
Concerned with the speed public info is incorporated into prices.

Question 8

What is the Included in Semi-Strong Form Efficiency?

Answer 8

All past prices
Financial statements
News
Announcements

Question 9

What are Implications of Semi-Strong Form Efficiency?

Answer 9

Cannot consistently earn excess returns using publicly available info.
Fundamental & technical analysis will not outperform the market on average.

Question 10

What is the Definition for Strong Form Efficiency?

Answer 10

All public/private info is fully reflected in current prices so no one can consistently earn excess returns.
Insider trading cannot yield abnormal profits.
Markets are perfectly efficient, no info advantage exists.

Question 11

What are the Implications of Strong Form Efficiency?

Answer 11

Active management is futile, will not be able to beat the market.
Challenges the value of fundamental analysis, insider knowledge, and even some forms of regulation.

Question 12

Why do Anomalies Arise?

Answer 12

Behavioural Bias - investors not always rational.
Information asymmetry - inefficiencies in strong form EMH
Accounting/Reporting Issues - misevaluations of complex statements