Q1. What is EMH?

Discuss in detail the evidence for and

against?
A market that adjusts rapidly to new information.
When market is fully passing out the correct or the exact information and the
stock prices are exactly according to their intrinsic value, state by the theory
Efficient Market Hypothesis. This theory tells that at any given time,
security prices fully reflect all available information. The implications of the
efficient market hypothesis are truly profound. Most individuals that buy and
sell securities (stocks in particular), do so under the assumption that the
securities they are buying are worth more than the price that they are
paying, while securities that they are selling are worth less than the selling
price. But if markets are efficient and current prices fully reflect all
information, then buying and selling securities in an attempt to outperform
the market will effectively be a game of chance rather than skill.
It says that it is impossible to "beat the market" because stock market
efficiency causes existing share prices to always incorporate and reflect all
relevant information. According to the EMH, stocks always trade at their fair
value on stock exchanges, making it impossible for investors to either
purchase undervalued stocks or sell stocks for inflated prices. As such, it
should be impossible to outperform the overall market through expert stock
selection or market timing, and that the only way an investor can possibly
obtain higher returns is by purchasing riskier investments.

Evidence for EMH

Random walk behavior of the stock prices

The random walk theory asserts that price movements will not follow any
patterns or trends and that past price movements cannot be used to predict
future price movements. An important implication of the efficient market
hypothesis is that stock prices should approximately follow a random walk;
that is, future changes in stock prices should, for all practical purposes, be
unpredictable.

Stock prices reflect publically related information

The price of the stocks fully reflects the information which public gathers
from the trend in the market and thus the market price of the stocks are

exactly according to the intrinsic or the par value of the stocks. Which ensure
that the investor cannot get abnormal profits over trading in the stocks.

Performance of investment analysts and mutual funds

Financial analysts who are specialized in the investment sector have seen in
the past that they randomly failed to beat the market. We have seen that
one implication of the efficient market hypothesis is that when purchasing a
security, you cannot expect to earn an abnormally high return, a return
greater than the equilibrium return. This implies that it is impossible to beat
the market. Many studies shed light on whether investment advisers and
mutual funds beat the market. One common test that has been performed is
to take buy and sell recommendations from a group of advisers or mutual
funds and compare the performance of the resulting selection of stocks with
the market as a whole. At the end, the failed to do so and their observations
are mostly not according to the market trend.
Mutual funds also do not beat the market. Not only do mutual funds not
outperform the market on average, but when they are separated into groups
according to whether they had the highest or lowest profits in a chosen
period, the mutual funds that did well in the first period do not beat the
market in the second period. The conclusion from the study of investment
advisers and mutual fund performance is this: Having performed well in the
past does not indicate that an investment adviser or a mutual fund will
perform well in the future.

Technical Analysis

A popular technique used to predict stock

prices, called technical analysis, is to
study past stock price data and search for
patterns such as trends and regular
cycles. Rules for when to buy and sell

stocks are then established on the basis

of the patterns that emerge. The efficient
market
hypothesis
suggests
that
technical analysis is a waste of time. The
simplest way to understand why is to use
the random-walk result derived from the
efficient market hypothesis that holds
that past stock price data cannot help
predict changes.
Evidence against EMH

Small firm Effect

One of the earliest reported anomalies in

which the stock market did not appear to
be efficient is called the small-firm effect.
Many empirical studies have shown that
small firms have earned abnormally high
returns over long periods of time.
Rebalancing of the portfolios by the
investor could be the reason for getting
the abnormal profit over specific period of
time.

Or that it may be due to low liquidity of

small-firm stocks, or large information
costs in evaluating small firms

January Effect

Over long periods of time, stock prices

have tended to experience an abnormal
price rise from December to January that
is predictable and hence inconsistent with
random-walk behavior. This so-called
January effect seems to have diminished
in recent years for shares of large
companies but still occurs for shares of
small
companies.
Some
financial
economists argue that the January effect
is due to tax issues. Investors have an

incentive to sell stocks before the end of

the year in December, because they can
then take capital losses on their tax
return and reduce their tax liability. Then
when the New Year starts in January, they
can repurchase the stocks, driving up
their prices and producing abnormally
high returns.

Other seasonal Effects

Holiday and turn of the month effects have been well documented over time
and across countries.

Q2. What is weak, semi-strong and strong form of EMH?

There are 3 types of Efficient Market Hypothesis which are as under:
1. Weak form of Hypothesis
The "Weak" form asserts that all past market prices and data are fully
reflected in securities prices. The prices of the stocks already represents the
past data related to those securities therefore it shows the exact price of that
particular stock. In other words, technical analysis is of no use.
2. Semi-strong form of Hypothesis
The "Semi-strong" form asserts that all publicly available information is fully
reflected in securities prices. As one can gain a profit that exceeds from their
expectations if he/she gets the hidden information, because if they will come
to know about any specific security, an investor will take decision according
the news they got. An example could be:
Information comes out that the prices of wheat will reduce in the coming
days because of the good progress and higher competition among the wheat

industry, this information will make sure to the investor that they dont
purchase any more stock of the wheat sector and instead of buying more
stocks they will sell the stocks to get the maximum benefit from those
security because they came to know that the prices of wheat will decrease
which will effect in the decrease of the stock prices to that specific item.
In other words, fundamental analysis is of no use.
3. Strong form of Hypothesis
The "Strong" form asserts that all information is fully reflected in securities
prices. In other words, even insider information is of no use. Stronger
hypothesis says that the market is very well based on the information and
the price changes accordingly therefore you cannot get the maximum profits
or abnormal return over the investment.

Q3. Some economist says that EMH is responsible for the

global financial prices. Do you agree or disagree. Discuss?
I personally dont agree with this statement that EMH was held responsible
for the recent global financial meltdown. The answer is no. Eugene Fama of
the University of Chicago in the 1960s, states that the prices of securities
reflect all known information that impacts their value. The hypothesis does
not claim that the market price is always right. On the contrary, it implies
that the prices in the market are mostly wrong, but at any given moment it is
not at all easy to say whether they are too high or too low. The fact that the
best and brightest on Wall Street made so many mistakes shows how hard it
is to beat the market. This does not mean the EMH can be used as an excuse
by the CEOs of the failed financial firms or by the regulators who did not see
the risks that subprime mortgage-backed securities posed to the financial
stability of the economy.
Misunderstanding efficient markets
There is a lot of wisdom in Stephen Brown's argument that it wasn't
excessive belief in efficient markets that caused the financial crisis it was
the failure to understand the efficient market hypothesis.
Many commentators have suggested that economists in general and
financial economists in particular have some responsibility for the recent
global financial crisis. They were blinded by an irrational faith in a discredit
Efficient Markets Hypothesis and failed to see the bubble in asset prices and
to give due warning of its collapse. There is considerable confusion as to

what this hypothesis is and what it says. The irony is that the strong
implication of this hypothesis is that nobody, no practitioner, no academic
and no regulator had the ability to foresee the collapse of this most recent
bubble. While few economists believe it is literally true, this hypothesis is
considered a useful benchmark with some important practical implications.
Indeed, a case can be made that it was the failure to believe in the essential
truth of this idea which was a leading factor responsible for the global
financial crisis
Our crisis wasn't due to blind faith in the Efficient Market Hypothesis. The
fact that risk premiums were low does not mean they were nonexistent and
that market prices were right. Despite the recent recession, the Great
Moderation is real and our economy is inherently more stable.
But this does not mean that risks have disappeared. To use an analogy, the
fact that automobiles today are safer than they were years ago does not
mean that you can drive at 120 mph. A small bump on the road, perhaps
insignificant at lower speeds, will easily flip the best-engineered car. Our
financial firms drove too fast, our central bank failed to stop them, and the
housing deflation crashed the banks and the economy.