TABLE OF CONTENTS
INTRODUCTION – AN OVERVIEW OF EFFICIENT MARKET
Market Efficient Theory is not a new concept in modern finance; the findings following Degutis (2014) was initially originated from the 19th century. Over the years, the theory draws attentions of many researchers with growing percentage of theories around the matter. One of the first economic researchers of the subject is Fama (1970), whose work at the time has successfully proved the dominance of EMH.
With modern financial analysis, the efficient stock market is considered as ‘a market
where stock prices can incorporate fundamental information about the companies’
(Degutis, 2014). Following the definition, the market value of the firm will fluctuate by
the ‘intrinsic value` of the business. On the other hand, Goedhart and Koller (2010)
said that due to the different in the transactions costs and the awareness of
investors; these underlying information sometimes unable to cohered with the share
prices which creates a gap between the intrinsic value of the firm and the market
prices. Furthermore, there are many other studies which offer different perspectives
on the matter also such as Eakins and Mishkin (2012), stated that asset prices will
be coherence with available information in an efficient market which was supported
by Brealey and Myers (2011). From the studies around EMH, there are two major
findings; the first one is that in an efficient market; the market absorb the information
fully and the second implication is about the low change of identifying anomalies.
Following Degutis (2014), there is three type of EMH depending on the ability to
reflect the performance of the market prices from the information including weak
form; semi-strong form and strong efficiency form of efficient market. Roberts (1967)
first suggesting the separation of market efficiency into strong and weak forms.
Firstly, a weak form of the efficient market reflects all ‘past information’ into the
prices` performance as the result; ‘there`s no technical analysis can forecast prospect
since past profit pattern are not correlated, and therefore it cannot use for
interpreting the future` (Harder, 2008). Secondly, a Semi-strong form of efficient
market able to reflect publicly available information such as dividends, fusions, etc.
Lastly, the strong form of the efficient market reflects both public and private
information into share prices performance.
EFFECTIVENESS OF EFFICIENT MARKET HYPOTHESIS
STRONG FORM OF EFFICIENT MARKET
The strong form of the efficient market was tested in many papers including
the study of Ajlouni (2004) as the database was based on the data of
FTSE100 from May 1999 to July 2000. The ‘study event method` was applied
to the calculation of expected returns from cumulative abnormal returns and
simple Market Model parameters in the Capital Asset Pricing Model (CAPM).
As the result, the study has determined that London Stock Exchange (LSE) is
significantly inefficient in term of the strong level of market efficiency.
SEMI-STRONG FORM OF EFFICIENT MARKET
Following Spyrou et. al. (2007) on the semi-strong test in LSE, large
capitalization indices react much stronger to positive/negative shocks. The
data was captured from 1998 to 2004 calculating the differences between
today and the day before closing price.
WEAK FORM OF EFFICIENT MARKET
Weak-form of an efficient market is tested for the FTSE 30 share index. The
result pointed out that the weak form of the efficient markets hypothesis is not
valid for the FTSE 30 share index (Al-Loughani and Chappel, 1997).
However, following Milionis and Moscho (2000); the finding was different as
‘validity of the weak-form efficient markets hypothesis is applied to (LSE)
London Stock Exchange.`
Various tools as well as correlation tests between past information and stock
returns were performed in relation to the popularity of the EMH theory about
the dependence of returns including Brealey and Myers (2011); which
suggested that previous day’s stock returns do not have impact on the next
day stock return performance by considering some of the major firms’
correlation coefficient over 2 days. Though, some may criticize that the length
two days isn`t enough for such argument such as Degutis (2014). But in
support of such theory, several other tests were also conducted by Brealey
and Myers (2006) on a weekly basis with similar outcomes. Also, the two tests
by Jensen (1978) and Shleifer (2000) also supporting the idea of the
independency of the stock returns to past data
Also, the speed of reflection of information into prices also support the validation of
EMH following Schleifer (2000) research which insisted that the semi-strong form of
EMH was by the price correction mechanisms. Furthermore, due to the time of the
announcement of information as considered to be happened after the stock price
movement following with the concerns of the information misleading as well as the
price adjustments. It is argued to be a response to new information flow at the time
of announcement following the fluctuation of the price (Schleifer, 2000).
On the other hand, despite the numbers of studies, literature that promotes the
validity of the EMH theory, there are also quite a few number of researches said
otherwise; denying the use and application of the theory in particular following the
study of Malkiel (2001), suggested that for small businesses, the returns were
roughly 1.4 times higher compare to larger firms. The research contributed to the
studies evolving around the considerations of abnormally high returns of small
companies than with big companies/corporations. Different studies about the
inefficiency of the market based on the analysing of matters such as the P/E and
P/BV ratios by Campbell and Shiller (1998) or the ‘January effects’ by Eakins and
Mishkin (2012) or (Schwert, 2003) also against the EMH theory.
PERFORMANCE OF THE ACTIVE PORTFOLIO
PERFORMANCE OF MY PORTFOLIO
The portfolio is made up initially from following stocks in the table follows:
Table: Selected stocks
No. Name of the company 1 Tullow Oil
3 ICAP Plc 4 Fresnillo
EPIC Code TLW
SRP IAP FRES
Price 160 p 80.05 p 412.10 p 976 p
Date of purchase 23-02-2016
23-02-2016 23-02-2016 23-02-2016