“In an efficient market, security (example shares) prices rationally reflect available information” (Arnold 2005, p.684). The efficient market hypothesis (EMH) refers to share price movement with respect to available information and thus no trader will be presented with an opportunity of making supernormal profits (except by chance), therefore their profits on a share will reflect the riskiness associated with that shares (Pike and Neal 2009). However, “detailed investigations using advanced econometric techniques, larger data sets, increasingly powerful computing ability, and alternative theoretical models have in the last few years revealed a range of anomalies when the unpredictability-of -returns hypothesis is tested. Financial markets are often predictable to some extent, but the crucial question is whether this predictability can be exploited to make excess profits from trading in the markets‖ (Mills 1992, as cited by Coutts, 2000, p.579).
Warren Buffet, known as one of the most successful investors in history, is convinced that stock markets are inefficient. ''I think it's fascinating how the ruling orthodoxy can cause a lot of people to think the earth is flat. Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn't do any good to look at the cards'' (Buffet, 1984, as cited by Davis, 1990, p.4).
Buffet is referring to the fact that market price movements are often caused by emotional purchases and sales of stocks, resulting to an inefficient market, in other words, irrational market prices (Buffet, 1984). However, there are financial economists who see it the other way round. They agree with the “Efficient Market Hypothesis” which states that security prices rationally reflect only available information (Arnold, 2005, p. 684) (see fig 1) therefore inhibiting the possibility of beating the market. According to this theory, there does not exist under- or overvalued shares, only true and fair values. It is difficult to say which side is right and which side is wrong, as both are based on logical reasoning and transparent facts. This paper will therefore, evaluate both concepts using different theories and ideas from those for and those against the EMH in order to find a conclusion which is reasonable and flexible enough to support a constructive point of view (based on pragmatism) and to better understand if Buffet‟s statement is true or false or maybe both.
Table of Contents
- Introduction
- The Efficient Market Hypothesis (EMH)
- Forms of Market Efficiency
- Fundamental vs. Technical Analysis
Objectives and Key Themes
This essay aims to evaluate the Efficient Market Hypothesis (EMH) and its implications for investment strategies, considering contrasting viewpoints from both proponents and critics of the theory, particularly Warren Buffet's perspective. The essay explores the debate surrounding market efficiency and whether it's possible to consistently achieve above-average returns.
- The Efficient Market Hypothesis (EMH) and its different forms.
- The contrasting views of market efficiency: Efficient versus inefficient markets.
- Fundamental analysis and its role in identifying undervalued assets.
- Technical analysis and its application in predicting market trends.
- Market anomalies and their implications for investment strategies.
Chapter Summaries
Introduction: This introductory section sets the stage for the essay by presenting Warren Buffet's quote highlighting the discrepancy between the belief in efficient markets and the reality of market behavior. It introduces the Efficient Market Hypothesis (EMH) and its core tenets, establishing the central debate between those who believe in market efficiency and those who believe in the possibility of identifying and exploiting market inefficiencies. The essay's objective to evaluate these opposing views and provide a balanced conclusion is clearly outlined. The introduction effectively lays the groundwork for the comprehensive discussion to follow.
The Efficient Market Hypothesis (EMH): This section delves into the core principles of the EMH, explaining how share prices reflect available information, thus preventing the consistent generation of above-average profits except through chance. It introduces the counterargument that market predictability exists and can be leveraged for excess profits. The contrasting views of Warren Buffett, who believes markets are inefficient due to emotional trading, and financial economists who support the EMH, are presented. The section sets the stage for a critical evaluation of both perspectives, acknowledging the logical reasoning behind both efficient and inefficient market theories.
Forms of Market Efficiency: This section details Fama's three forms of market efficiency: weak, semi-strong, and strong. Weak-form efficiency suggests that past price movements don't predict future prices. Semi-strong form asserts that all publicly available information is already reflected in prices. Strong-form efficiency implies that all information, including private information, is reflected in prices. The discussion highlights the implications of each form for investment strategies, outlining how the level of market efficiency influences the potential for generating above-average returns through different investment approaches.
Fundamental vs. Technical Analysis: This chapter contrasts fundamental analysis, which focuses on intrinsic value based on underlying company information, and technical analysis, which analyzes past price patterns to predict future movements. It discusses how these methods relate to the EMH, with fundamental analysis suggesting the inability to consistently identify undervalued assets unless analysts possess unique information or engage in insider trading. The chapter introduces Warren Buffett's opposing stance and the concept of identifying undervalued assets through detailed fundamental analysis, illustrating how skilled analysts can profit from market inefficiencies.
Keywords
Efficient Market Hypothesis (EMH), market efficiency, Warren Buffett, investment strategies, fundamental analysis, technical analysis, market anomalies, undervalued assets, stock prices, risk, return.
Frequently Asked Questions: A Comprehensive Language Preview
What is the main topic of this text?
This text is a comprehensive language preview of an essay evaluating the Efficient Market Hypothesis (EMH) and its implications for investment strategies. It examines the contrasting viewpoints of proponents and critics of the EMH, particularly Warren Buffett's perspective, and explores the debate surrounding market efficiency and the possibility of consistently achieving above-average returns.
What are the key themes explored in the text?
The key themes include the Efficient Market Hypothesis (EMH) and its different forms (weak, semi-strong, and strong); contrasting views on market efficiency (efficient vs. inefficient markets); the roles of fundamental and technical analysis in investment strategies; market anomalies and their impact; and the perspectives of Warren Buffett and financial economists on market predictability.
What is the Efficient Market Hypothesis (EMH)?
The Efficient Market Hypothesis posits that asset prices fully reflect all available information. This implies that it's impossible to consistently achieve above-average returns except through luck, as any profitable opportunities are quickly exploited by others. The text explores various forms of the EMH and critiques of this theory.
What are the different forms of market efficiency?
The text details Fama's three forms: weak-form efficiency (past prices don't predict future prices), semi-strong-form efficiency (all publicly available information is reflected in prices), and strong-form efficiency (all information, including private information, is reflected in prices). Each form has different implications for investment strategies.
How does the text discuss fundamental vs. technical analysis?
The text contrasts fundamental analysis (analyzing a company's intrinsic value) and technical analysis (analyzing past price patterns). It explores how these approaches relate to the EMH and how they can be used (or not) to achieve above-average returns. The opposing views of Warren Buffett, who emphasizes fundamental analysis, are presented against the backdrop of the EMH.
What is Warren Buffett's perspective on market efficiency?
Warren Buffett's perspective is presented as a counterpoint to the EMH. He believes markets are inefficient due to emotional trading and that skilled investors can identify undervalued assets through thorough fundamental analysis, thereby achieving above-average returns. His views are highlighted throughout the text as a key contrasting perspective.
What are the chapter summaries included in the preview?
The preview includes chapter summaries for the Introduction, The Efficient Market Hypothesis (EMH), Forms of Market Efficiency, and Fundamental vs. Technical Analysis. Each summary provides a concise overview of the content and arguments presented in the corresponding chapter.
What are the keywords associated with this text?
The keywords include Efficient Market Hypothesis (EMH), market efficiency, Warren Buffett, investment strategies, fundamental analysis, technical analysis, market anomalies, undervalued assets, stock prices, risk, and return.
What is the overall objective of the essay previewed in this text?
The objective is to provide a balanced evaluation of the Efficient Market Hypothesis, considering both supporting and opposing arguments, particularly the perspective of Warren Buffett. It aims to examine whether consistent above-average returns are possible and explores the implications for various investment strategies.
- Citation du texte
- Charles Ekweruo (Auteur), 2011, “Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn’t do any good to look at the cards.”, Munich, GRIN Verlag, https://www.grin.com/document/183394
