Table of contents

  LIST OF ABBREVIATIONS  2

  LIST OF FIGURE  2

  EXECUTIVE SUMMARY  2

1.  INTRODUCTION  3

2.  EFFICIENT MARKET HYPOTHESIS  3

2.1  MARKET EFFICIENCY  3

2.2  THREE LEVELS OF EFFICIENT MARKETS  4

2.3  MYTH ABOUT THE EMH  4

3.  INFORMATION ABOUT EMPIRICAL RESULTS  4

4.  IMPLICATIONS OF THE EMH FOR INVESTORS  5

4.1  WHEN THE WEAK-FORM OF THE EMH HOLDS  5

4.1.1  Technical Analysis is useless  5

4.2  WHEN THE SEMI-STRONG FORM OF THE EMH HOLDS  6

4.2.1  Fundamental Analysis is useless  6

4.2.2  The study of published accounts is useless  6

4.2.3  The most tips are worthless  7

4.2.4  The search for undervalued companies is useless  7

4.2.5  Portfolio diversification is important to reduce non-systematic risk  7

4.2.6  Transaction costs should be as low as possible  8

4.2.7  Unit Trusts do not perform better than their beta  8

4.3  WHEN THE STRONG-FROM OF THE EMH HOLDS  8

4.3.1  Insider information are useless  9

5.  IMPLICATIONS OF THE EMH FOR MANAGER  9

5.1  ACCOUNTING DISCLOSURE TO DECEIVED SHAREHOLDERS IS USELESS  9

5.2  MARKET VALUE AS INDICATOR FOR COMPANY VALUE AND MANAGEMENT DECISIONS  9

5.3  COMPANIES DO NOT NEED SPECIALISTS FOR THE TIMING OF NEW ISSUES  10

5.4  THERE ARE NO OPPORTUNITIES FOR A CHEAP ACQUISITION  10

6.  CONCLUSION  11

7.  BIBLIOGRAPHY  12

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List of Abbreviations

eg. exempli gratia (for example)

EMH Efficient Market Hypothesis

et al. et alii (and others)

etc. etcetera (and so on)

i.e. id eat (that is, that means)

List of Figure

Figure 1: Efficient Market 3

Executive Summary

The study examines and critical reviews the literature for the different implications based on the three levels of the Efficient Market Hypothesis for investors and company managers. If the weak form of the EMH holds, the technical analyse is useless, but ninety percent of traders in London are using it. If the semi-strong-form holds the fundamental analysis, study of published accounts, search for undervalued companies are useless and investors should be focus on diversification and avoiding of transaction costs. Furthermore the semi-strong form would imply for managers, that accounting disclosure to deceived shareholders is useless, the company market value is the best indicator for the company value and management decisions, the company does not need specialists for the timing of issues and there are no opportunities for a cheap acquisition of another company. At least if the strong-form of the EMH holds, it would imply that even with insider information it would not be possible to get above average returns. The literature shows, that the studies of EMH have made an important contribution to our understanding of the security market. It also shows that in some cases scientific results do not strong influence the behaviour of manager and investors in the “real world”.

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1. Introduction

The historical background of the EMH is more than hundred years old and based on Bachelier (1900), when he speculated that stock prices followed a Brownian motion, the path breaking point of this was that this means that stock price movements for the future are unpredictable. Kendall (1953) picked up Bacheliers idea for his analyses and came to the conclusion that stock prices seem to follow a random walk. Twelve years later, also Samuelson (1965) analyses about stock prices confirmed these results. Fama (1969) researched the adjustment of stock prices and one year later Fama (1970) published a path breaking work in which he defined three different levels of market efficiency, the weak-form, the semi-strong-form, and the strong-form, this triggered a huge wave of research studies. Just eight years later Jensen (1978, p.1) wrote about the EHM that he believed that there is “no other proposition in economic which has more solid empirical evidence supporting it”. However, the existence of efficient capital markets has important implications for investors and of the manager of companies, (Brayshaw, 1994).

The goal of this study is to examine and critical review the different implications of the EMH shown in the literature for investors and company managers.

2. Efficient Market Hypothesis

2.1 Market efficiency

According to Fama (1969, p.1) an efficient market is a market, which “adjusts rapidly to new information”. Based on the concept of Fama (1970), information efficient capital market is

reflect all information about past events and expected events in the future. Thirdly, allocation efficient, i.e. the capital market allocated funds to where they can be best used.

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2.2 Three Levels of efficient markets

Fama (1970) defines the following three different levels of the EMH:

1. Weak efficiency of the EMH claims that all information of past prices are reflected in the actual share price. Future price movements cannot be predicted by using past prices.

2. Semi-strong efficiency of the EMH claims that all public available information are already reflected by the actual share price.

3. Strong efficiency of the EMH claims that all information, whether public or private, are already reflected by the actual share price.

According to Beaver (1983), the concept of Fama, despite of some eventual content weaknesses, undisputed in its vital role for empirical research.

2.3 Myth about the EMH

The biggest myth about the EMH is that the EMH claims that investors cannot outperform the market and based on that some successful analysts (George Soros, Warren Buffet etc.) did exactly that in the last years and therefore the EMH must be incorrect (Clarke, 2001). But the EMH does not entail that nobody is unable to outperform the market, it just claims that nobody shout expected to outperform the market consistently. If an investor picks stocks randomly he has a fifty percent chance of beating the market. Therefore the chance of outperforming the market for the next ten years would be 0.5 ¹⁰ . This implies that the chance is 99.99% to find one successful investor in beating the market for 10 years in a group of 10,000 investors (Clark, 2001).

3. Information about Empirical Results

The EMH has been examined extensively in many studies. This data will be used in this study to critical review and discuss the implication based on the EHM. But it should be noted that all tests, just test a specific piece of information in one or some specific market at a specific time. According to Brayshaw (1994), specific results of empiric tests about the EMH are not transferable over time or between markets.

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