This Master Thesis gives an overview of the research into the efficient market hypothesis from its first days in the 1950s to the present. The discussion of theoretical models and concepts is being complemented by a review of relevant empirical evidence from international capital markets. The thesis is completed by a brief outlook on newer research venues, including models employing behavioural finance approaches.
Table of Contents
1. Introduction
2. What is the Efficient Market Hypothesis?
2.1. Definition of Market Efficiency
2.1.1. The Three Forms of Market Efficiency
2.1.2. Limits of Efficiency
2.1.3. Questions Left Unaddressed
2.2. A Short History of the Efficient Market Hypothesis
3. Explanatory Models of Market Behaviour
3.1. Expected Return Efficient Market Models
3.1.1. The Fair Game Model
3.1.2. The Submartingale Model
3.1.3. The Random Walk Model
3.1.4. The Capital Asset Pricing Model
3.1.5. The Market Model
3.2. Variance Efficient Market Models
3.3. Behavioural Models
4. Testing for Market Efficiency
4.1. Tests for Weak-Form Efficiency
4.2. Tests for Semistrong-Form Efficiency
4.2.1. Event Studies
4.2.2. Mutual Fund Studies
4.3. Tests for Strong-form Efficiency
5. Evidence of Market Efficiency
5.1. Market Anomalies
5.1.1. Serial Correlation
5.1.2. Return Seasonality
5.1.3. Stock Price Reaction to Index Inclusion
5.1.4. Neglected-Firm Effect and Liquidity Effect
5.2. Insider Information
5.2.1. Legislative Treatment of Insiders
5.3. Mutual Fund Performance
5.3.1. Methodology of Mutual Fund Studies
5.3.2. Evidence of Mutual Fund Performance
5.4. Short-Term Momentum and Long-Term Reversal
5.4.1. Evidence for Trend Reversal
5.4.2. Evidence for Momentum
5.4.3. Possible Explanations for the Momentum and Reversal Effects
5.5. Evidence from the Austrian Market
5.5.1. Pichler’s 1993 Test
5.5.2. Aussenegg and Grünbichler’s 1999 Study
5.5.3. Mestel and Gurgul’s 2003 Test
5.5.4. Gurgul, Mestel, and Schleicher’s 2003 Test
5.5.5. Other Evidence
5.6. Evidence from the German Market
5.6.1. Uhlir’s 1984 Review
5.6.2. Krämer and Runde’s 1993 Study
5.6.3. Glaser and Weber’s 2003 Study
5.6.4. Other Evidence
5.7. Evidence from Bond Markets
6. Summary and Conclusion
Objectives and Topics
This thesis examines the validity of the Efficient Market Hypothesis (EMH) within contemporary financial markets, evaluating both theoretical models and empirical evidence against the paradigm.
- Theoretical foundations and definitions of market efficiency
- Explanatory models of market behaviour (CAPM, random walk, behavioural models)
- Methodologies for testing market efficiency, including event studies and mutual fund analysis
- Market anomalies and the evidence from international markets (Austria, Germany, U.S.)
- Analysis of momentum effects, trend reversals, and the role of insider information
Excerpt from the Book
3.1.1. The Fair Game Model
Fama (1970) lists three models describing the characteristics inherent to an efficient market – the fair game, random walk and martingale/submartingale models. What they have in common is their reliance on expected returns for the description of market efficiency. Putting this common characteristic into mathematical notation yields the following equation: [ ] ( [ ]) j t t j t t j t E p E r p , 1 , 1 , ~ 1 ~ Φ = + Φ ⋅ + + (2)
The value of [ ] j t t E r , +1 Φ ~ is determined by the particular expected return model employed. Equation (2) only states that the information set Φt is fully reflected in [ ] , 1 ~ E p j t+ , the price in one period as expected at time t .
This above definition leads to viewing expected return efficient market models as “fair game” models. The rationale of fair game efficient market models is that no trading system based solely on the information set Φt can have expected returns exceeding equilibrium expected returns.
Summary of Chapters
1. Introduction: Presents the EMH as a core paradigm in modern finance and outlines the thesis's purpose to assess its validity in real-world markets.
2. What is the Efficient Market Hypothesis?: Defines market efficiency based on the incorporation of information into security prices and provides a brief historical context.
3. Explanatory Models of Market Behaviour: Introduces common frameworks used for testing market efficiency, including return-based, variance-based, and behavioural models.
4. Testing for Market Efficiency: Discusses the methodological challenges in testing EMH and details approaches like event studies and mutual fund performance reviews.
5. Evidence of Market Efficiency: Reviews empirical findings regarding market anomalies, insider trading, momentum strategies, and regional evidence from Austria and Germany.
6. Summary and Conclusion: Synthesizes the literature, acknowledging that while markets do not perfectly conform to strong-form efficiency, they exhibit varying degrees of efficiency influenced by transaction costs.
Keywords
Efficient Market Hypothesis, Market Efficiency, Asset Pricing Models, Capital Asset Pricing Model, Behavioral Finance, Market Anomalies, Momentum, Trend Reversal, Insider Trading, Mutual Fund Performance, Liquidity Effect, Financial Markets, Empirical Research.
Frequently Asked Questions
What is the core focus of this thesis?
The work focuses on the Efficient Market Hypothesis (EMH), evaluating its theoretical basis, testing methodologies, and its validity when confronted with empirical evidence from various financial markets.
What are the primary themes covered?
Central themes include the definitions of market efficiency, various explanatory models (e.g., CAPM, Fair Game), empirical testing methods, and the critical analysis of market anomalies like momentum, reversal, and the impact of insider information.
What is the primary goal of the research?
The research aims to explain the reasoning behind the EMH and document literature regarding its validity or lack thereof in today's financial markets.
Which scientific methods are analyzed?
The study examines quantitative models such as the Fair Game model, the Random Walk model, the Capital Asset Pricing Model (CAPM), and event study methodologies used to test for weak, semistrong, and strong-form efficiency.
What does the main body address?
The main body covers a comprehensive review of theoretical market models followed by an extensive empirical section reviewing tests for efficiency across various time horizons, stock markets, and asset classes.
Which keywords define this work?
Key terms include Efficient Market Hypothesis, Market Efficiency, Asset Pricing, Behavioral Finance, Market Anomalies, and Momentum strategies.
How does the thesis define "immediate" price adjustment?
It defines "immediately" in the context of a non-continuous trading process, referring to the first trade in a security after new information has been made public.
What role do transaction costs play in efficiency?
The thesis argues that transaction costs create a tolerance band around efficient prices, suggesting that markets might be considered efficient if deviations from "true" value are too small to be profitably exploited net of costs.
- Quote paper
- Stefan Palan (Author), 2004, The Efficient Market Hypothesis and its Validity in Today's Markets, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/32694
