Chapter 8 Efficient Market Hypothesis
Is there a pattern in the evolution of stock prices??
Stock prices follow a random walk; i.e. at any time, it cannot be said whether the stock price of a company will increase, decrease or remain unchanged. This random evolution of stock prices is due to the random manner in which information affects a stock market. Investors take into consideration information, so as reassess a stock’s prospects and accordingly adjust their buying and/or selling. It is known that the market price of a stock is established through the forces of demand and supply.
Efficient market hypothesis: If a market is efficient, this implies that at all instants, the prices of securities reflect all available information. (Fama 1970)
1. Anticipated/unanticipated information
2 types of information are integrated in stock prices:
- Anticipated information
- Unanticipated information
1. Anticipated information
- Future events that can be forecasted with a certain degree of accuracy.
Forecast of a company’s earnings; the economic conditions prevail next year...
E.g. a company forecasts high profits for the coming year; has a positive impact on the company’s stock price.
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As the information is being anticipated, it will start having a positive impact on the stock price prior to the date that the figures of high profits are released. If the market is efficient, when the profit figures are released (event time), this information is completely assimilated and the stock price stabilises at a higher level.
(Negative anticipated event would have resulted in a gradual decrease in stock price, up to the event time; where the stock price stabilises at a lower le ...