Solution:

i/-  The efficient market hypothesis means that the market cannot be beaten because it takes into account all important information into current share prices, so stocks trade at the fairest value. The theory is offered in three different versions: weak, semi-strong, and strong.

Weak Form: The weak form suggests that today’s stock prices reflect all the data of past prices and that no form of technical analysis can be effectively utilized to help investors in making trading decisions. Some people believe that if the fundamental analysis is used, undervalued and overvalued stocks can be determined, and investors can research companies financial statements to increase their chances of making higher-than-market-average profits.

Semi Strong Form: The semi strong form efficiency theory follows the belief that because all information that is public is used in the calculation of a stock's current price, investors cannot utilize either technical or fundamental analysis to gain higher returns in the market. Some believe that only information that is not readily available to the public can help investors boost their returns to a performance level above that of the general market.

Strong Form: The strong form states that all information both the information available to the public and any information not publicly known is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market. Some believe that investors cannot make returns on investments that exceed normal market returns, regardless of information retrieved or research conducted.

ii/- CAPM testing in different ways:  

Some level of risk will always exist even if you diversify your investments. So people want a rate of return that compensates for that risk. The capital asset pricing model helps to calculate investment risk and what return on investment an investor should expect. In equilibrium, the CAPM predicts that all investors hold portfolios that are efficient in the expected return standard deviation space. Therefore, the Market Portfolio is efficient.

Early tests focused on the cross section of stock returns. Test SML. Findings gave positive for CAPM, though the estimated risk-free rate tended to be high.

More modern tests focused on the time-series behavior. Test the SCL. Findings gave Negative for CAPM. because δ is significant.

Two pass technique: – First pass is a time series estimation where security (or portfolio) returns were regressed against a market index, m: Ri,t - rf = αi + βi (Rm,t - rf ) + εi,t (CAPM)

Second pass is a cross sectional estimation where the estimated CAPM beta from the first pass is related to average return.

iii/-

Stock market anomalies inevitably challenge the validity of the Efficient Market Hypothesis and the accuracy of the asset pricing model used in measuring stock returns. Therefore, the accuracy of the asset pricing model used to measure stock returns is in the centre of the market efficiency debate, and the CAPM is an extensively applied asset pricing model in the capital market. A stochastic version of the CAPM time series regression is normally adopted to estimate portfolio abnormal returns. Analysis found systematically high abnormal returns from portfolios of stocks with a low Price Earnings ratio relative to the portfolios consisting of stocks with a high Price Earnings ratio. This suggests anomalous pricing behaviour in capital market operations. Price-Earnings anomaly hypothesises either the CAPM is mis specified and/or capital markets are inefficient. If the CAPM appears to be a correctly specified asset pricing model that accurately explains stock returns in response to their true level of systematic risk, Price-Earnings anomaly evidently undermines the semi-strong form stock market efficiency.

Results of a two-pass regression approach similar to Black, Jensen and Scholes (1972) and Fama and Macbeth (1973) empirical work indicated that the CAPM-beta does not appropriately explain stock returns in specific country. As such, it appears that the CAPM suffers from deleted variable bias problem and hence mis specified. In the absence of statistically significant evidence to constitute accuracy of the CAPM, Price-Earnings anomaly observed appears to have been produced either by measurement inconsistencies of the mis-specified CAPM or by a combined effect of both CAPM misspecifications and capital market inefficiency. From the policy front, market efficiency is an important attribute and the accuracy of the asset pricing model is a vital strand in market efficiency tests.