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Which form of the efficient market hypothesis (EMH) is violated from the following observations? Explain
Which form of the efficient market hypothesis (EMH) is violated from the following observations? Explain.a. High price-to-earnings ratio (P/E) stocks tend to have positive abnormal returns.
b. By observing the historical prices and historical trading volume, small ‘high- tech’ firms’ stocks tend to have higher rates of return than other ‘blue-chip’ stocks.
Expert Solution
a. First statement violates "semi-strong form of efficient market hypothesis". The semi-strong efficiency form hypothesis contends that a security's price movements are a reflection of publicly-available material information. All the information of earnings is publicly available and therefore it is not possible to generate positive abnormal returns under semi-strong market hypothesis.
b. Weak form efficiency states that past prices, historical values and trends can't predict future prices. Weak form efficiency states that stock prices reflect all current information and is not possible that small ‘high- tech’ firms’ stocks tend to have higher rates of return than other ‘blue-chip’ stocks.
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