The Efficient Market Hypothesis
Objective…………………………………………………………………………………………………………………………………………………………………… 3
The Efficient Market Hypothesis…………………………………………………………………………………………………………………………….. 3
1.mobility………………………………………………………………………………………………………………………………………………………………….. 4
2.limitations……………………………………………………………………………………………………………………………………………………………… 4
Rational investor……………………………………………………………………………………………………………………………………………………… 4
The intrinsic value of stocks …………………………………………………………………………………………………………………………………… 5
- A. Discounted Cash Flow Model…………………………………………………………………………………………………………………………….. 5
- B. Internal rate of return model……………………………………………………………………………………………………………………………….. 5
- C. Zero growth model……………………………………………………………………………………………………………………………………………….. 5
- D. Constant growth model………………………………………………………………………………………………………………………………………. 5
Fundamental analysis………………………………………………………………………………………………………………………………………………. 6
Modern Portfolio Theory (MPT)…………………………………………………………………………………………………………………………….. 6
Mispriced securities ………………………………………………………………………………………………………………………………………………… 7
References…………………………………………………………………………………………………………………………………………………………………. 9
Objective
The purpose of this research is to understand the content and basic knowledge of the theory, which will play a role in our future research, and apply what we learned in this research to future learning and research .
The Efficient Market Hypothesis
Economists and academics have broadly acknowledged the efficient market hypothesis (EMH), as defined by Fama in his important survey article “Efficient Capital Markets” (Fama 1970), which states that securities markets are efficient in the reflection of
news/information about particular stocks or about the overall market as a whole . The generally accepted view is that the information flow is smooth, and that it is incorporated into the stock market without any delay . Therefore, technical analysis, which is the study of past stock prices in an effort to forecast future prices, and fundamental analysis, which is the exploration of financial information (such as asset values and company earnings) to help investors select “under-priced” stocks, may not permit an investor to realise returns greater than those that could be gained by holding a randomly chosen portfolio of stocks, at least not with comparable risk.
Characteristics of efficient markets
For an effective market, the speed of information integration is critical . The efficient market is to adjust the asset price according to the corresponding information . For investors, the higher the timeliness, the earlier they can predict the price, and the more timely they can judge the market trend. Faster people will certainly get more returns in one step .
1 .mobility
Effective markets can integrate information on the premise that information flows . Market behavior is group behavior, not individual or minority behavior. Only when most individuals in the market get information and respond to information, can the market show overall consistency .
2 .limitations
There is neither a completely effective market nor a completely ineffective market. Under certain circumstances, an effective market will also show inefficiency and confusion . This limitation mainly comes from the psychological characteristics of the group . The group’s mind is easy to reach a consensus, but it is also easy to be affected by external things, its own desires and other irrational factors . When the consensus reached by the group deviates from the objective facts and ignores some key factors, it is the time when an invalid market
appears .
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Rational investor
As far as the stock market is concerned, the behavioral characteristics of rational investors are mainly as follows: set exit and entry conditions and resolutely implement them, and rest at other times .
The partial or short-term ineffectiveness of the market is a mistake made by the market. It is rare for the market to make mistakes, especially consensus mistakes, but they always occur irregularly . Local mistakes will bring losses to local individuals, and the consequences of consensus mistakes will be borne by the whole market.
This is a rare opportunity for a few investors who can realize the mistakes of the market. In this invalid market, as long as they master certain investment strategies, they may get the best return .
What we should know is that this invalid market is partial and temporary . In the long run, the effectiveness of the market will always bring this disorder and confusion back to the normal track. When the market returns to effectiveness, the price will move closer to the value and eventually return to the value .
The intrinsic value of stocks
The intrinsic value of the stock is the value that analysts believe the stock represents after analyzing the company’s financial situation, profit prospects and other factors that affect the growth and decline of the company’s production and operation . This so-called intrinsic value depends on the views of analysts or investors in a sense, so different conclusions may be drawn about the same company . There are many methods to calculate the intrinsic value of stocks, but they are all calculated by converting future income into the present value (i .e . the present value of future payments) .
There are generally three methods: the first is the P/E ratio method. the second method, the asset appraisal value method,the third method is the sales revenue method.
The calculation methods and models of stock intrinsic value include:
A . Discounted Cash Flow Model
B . Internal rate of return model
C . Zero growth model
D . Constant growth model
Fundamental analysis
Fundamental analysis is an analysis method that starts from the sensitive factors that affect the changes of securities prices, analyzes and studies the general laws of price changes in the securities market, and provides scientific basis for investors to make correct decisions .
Fundamental analysis suggests that the market may incorrectly price securities in the short term, but it will eventually reach the correct price . Profits are generated by buying securities that are priced incorrectly and then waiting for the market to correct incorrect valuations .
The abnormal variables based on interest expense, sales and management expense are highly related to the degree of future stock returns . In a broad sense, these variables can predict the future stock returns, because they will contain relevant information about the future company performance value, and the market has failed to incorporate this information into the stock price in a timely manner.The authors plan to implement a fundamental analysis to make a comparison between Hilton Worldwide and
Marriott International , and determine which company possesses the better competitive advantage from a long-term perspective .
Modern Portfolio Theory (MPT)
Modern portfolio theory is a normative rather than a descriptive theory . It provides investors with solutions by showing the best combination of available assets in the
portfolio, so as to maximize the total expected return of a given risk, or to minimize the portfolio risk under a given expected return level .
In investment and wealth management, select products with different risks, conduct portfolio asset allocation, and reduce the volatility of the overall investment income through risk diversification .
Build investment portfolio between different markets and varieties to resist the systematic risk of single variety decline in the single market
Don’t put them all in the basket of high risks, but focus on the markets and fields that you know and are familiar with, and choose products with less relevance for asset allocation, so as to maximize investment performance, reduce risks and win the market.
The author believes that Hilton Group and Marriott Group belong to the same industry, and the risk differences between the two companies are difficult to compare and disperse . In the follow-up study, the author will further study the different shareholding percentages of different investors in the portfolio including hotel shares .
Mispriced securities
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Mispriced securities occurs because some agents rationally draw erroneous conclusions from the pricing system about information received by other investors .
In order to make a profit, investors should implement a short-selling or long-selling strategy according to the actual situation .
Rational investors
Investors are divided into rational investors and emotional investors . It is believed that
rational investors invest based on their own rational choices, which are influenced by goals
and risks, which rational investors will evaluate and judge tolerance for, and validate their conclusions against their goals . (Resource, 2018) . Rational investors are insightful investors who also profit from mispriced securities .
The author will follow the advice of rational investors when conducting follow-up research, because we find that under the influence of emotions, investors will find it difficult to time the market and make choices or prediction errors .
References
Degutis, Augustas, and Lina Novickyte . “THE EFFICIENT MARKET HYPOTHESIS: A CRITICAL REVIEW OF LITERATURE AND METHODOLOGY . ” Ekonomika – Vilniaus universitetas 93 .2 (2014) : 7–23 . Web .
Ying, Qianwei et al . “Stock Investment and Excess Returns: A Critical Review in the Light of the Efficient Market Hypothesis . ” Journal of risk and financial management 12 .2 (2019) : 97– . Web .
Beyhaghi, Mehdi, and James P . Hawley . “Modern Portfolio Theory and Risk Management : Assumptions and Unintended Consequences . ” Journal of sustainable finance & investment 3 . 1 (2013) : 17– 37 . Web .
Li, Kevin, and Partha Mohanram . “Fundamental Analysis: Combining the Search for Quality with the Search for Value . ” Contemporary accounting research 36 .3 (2019) : 1263– 1298 . Web .
Yan, Xuemin (Sterling), and Lingling Zheng . “Fundamental Analysis and the Cross- Section of Stock Returns: A Data-Mining Approach . ” The Review of financial studies 30 .4 (2017) : 1382– 1423 . Web .
Eckwert, Bernhard, and Andreas Szczutkowski . “Rationally Mispriced Assets in Equilibrium . ” Spanish economic review 8 .4 (2006) : 285–299 . Web .
Resource . 2018 . The Emotional vs . Rational Investor | Resource . [online] Available at : https://resourcereit.com/insight/the-emotional-vs-rational-investor/
[Accessed 28 April 2022] .
Mukherjee, Saptarshi, and Sankar De. “When Are Investors Rational?” The journal of behavioral finance 20. 1 (2019) : 1– 18. Web.
The Efficient Market Hypothesis
