Which Of The Following Are Consistent With The Efficient Markets Hypothesis? Check All That Apply.

4a . Summary

Undoubtedly, the studies based on EMH have made an invaluable contribution to our understanding of the securities market. However, there seems to be growing discontentment with the theory. A limited survey of the contemporary literature shows that criticism of EMH has gained both voice and momentum during recent years. While it is true that the market responds to new information, it is now clear that information is not the only variable affecting security valuation. Recent years have witnessed a new wave of researchers who have provided thought provoking, theoretical arguments and supporting empirical evidence to show that security prices could deviate from their equilibrium values due to psychological factors, fads, and noise trading.

4b . A Look into the Future

While the trial of EMH continues, we expect that the final outcome of the raging debate will be a compromise between competing schools of thought. In our opinion, knowledge of the dynamics of stock market behavior would perhaps be best advanced by adopting a multidisciplinary approach that incorporates both qualitative and quantitative research tools. To this end, we do not call for the abandonment of the EMH paradigm, but rather propose that the hitherto popular EMH paradigm be refined to embody the psychological and speculative aspects of the stock market. As Einhorn (1976) remarked, "We should always be open to the idea of developing new paradigms incorporating some aspect of decision making that has heretofore been neglected." [Einhorn, 205]

4c . Directions for Future Research

It is likely that the quest for a coherent theory of the stock market will continue to stimulate the intellect of academic researchers. It is apparent that, over the years, the field has made much progress and that without such sustained research efforts the issue would remain unresolved. The fresh insights on the speculative component have opened up several avenues for fruitful research. In our opinion, the critics of EMH must continue providing unambiguous, consistent, and direct empirical evidence on the irrational aspect of stock market behavior for their findings to be completely accepted in the discipline. Akerlof and Yellen (1985) show that even small amounts of irrationality could have significant economic effects. De Long, Schleifer, Summers and Waldmann (1989) observe that noise trading can have an adverse impact on other market participants. The social welfare implications of an irrational and speculative stock market, and the policies to control such behavior (if desirable) could be a profitable area for future research. In closing, with the EMH on trial, the field of securities market research is truly at the threshold of an exciting phase.

1. A review of studies in this area would be beyond the scope of this paper. For comprehensive reviews on the subject see Fama (1970, 1991) and Lev (1989).

2. Note that the Ball and Brown (1968) study is an association study. Event studies measure the price impact of an information event in a short window, whereas association studies measure the relative importance of an information event to stock price adjustments in a long window. For example, Ball and Brown show that annual net income number accounts for only twenty percent of the price adjustment in the month of release, implying that most information is captured by more timely media.

3. Proponents of the EMH would argue that the price reaction is either an information effect or a liquidity effect. The fact that S&P decided to include the stock might carry some positive news about the stock. Usually a stock has to meet stringent criteria to be eligible for inclusion in the index. This might be interpreted as good news resulting in a higher price. Alternately, indexing portfolios will include the stock, causing an abrupt increase in the demand for the stock, and improving liquidity for the stock. With improved liquidity, narrower spreads and a lower cost of capital result. The market's required return on the stock decreases, which results in a higher stock price.

4. Net asset value (NAV) is equal to the sum of the market values of all the fund's security positions, plus its cash and minus the liabilities. Shares in open-end funds (mutual funds) can be bought at the prevaililng NAV plus any load charge and redeemed at the NAV minus any redemption fee.

5. Most closed-end funds are listed on the NYSE. A relatively fewer number are traded on the Amex and NASDAQ.

6. For funds selling at a discount, it implies that the fund share price is lower than the per-share new asset value of the portfolio they hold. Thus the value additivity principle is violated.

(1) George Putnam of New Generation Research (WSJ, 1993), "Clearly, the bankrupt security market is not efficient. But that's why we like it;"

(2) George Soros of Quantum Fund, (Hedge, 1994) "In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium, and behave quite differently from what would be considered normal by the theory of efficient markets."

8. Another case in point is the common stock of LTV, which continued to trade on the NYSE at $2 a share, which was more than 60 times the value provided for the shares in the reorganization plan.

9. This was based on a study of the information effect of weather condition on the price of orange juice. One would think that such information would account for most of the variation in prices. But Roll found that only a fraction of the movement in orange juice future prices could be attributed to the news.

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