Part 1: Describe the theoretical aspects of market efficiency

Market Efficiency Hypothesis

Part 1

The market efficiency theory highlights that financial markets reflect known information available to the public. All the information relevant to influence financial market dimensions is also reflected in available stock markets. The assumption is that the pricing of financial securities is right (Gigan, 2015). Therefore, despite the dynamics in the market, the pricing does not change and is efficient to reflect the real value of such stocks. The efficient market hypothesis also reflects on historical data price (Gigan, 2015). Such price is reflected in the market price, and an investor cannot rely on technical analysis to outdo the overall market. The market efficiency denies investors the opportunity to exploit security mispricing through critical analysis. Neither fundamental analysis nor technical analysis can be relied on in outperforming market prices. Therefore, there is no particular way that investors can achieve excessive returns by altering the financial markets.  

Some of the evidence available for market efficiency includes market randomness. From my experience, focusing on the trend in stock prices it is relatively hard for companies to overvalue their stocks and attract new investor. The randomness in the market makes it relatively challenging to invest in a low-cost portfolio. Active managers outperform passive peers, especially related to bond funds and equity bonds (Nwaolisa & Kasie, 2012). There are low success rates in capped market funds. Investors can only fair well in low-index funds. According to Gigan (2015),market efficiency supports fairness in the accurate pricing in stocks, reducing the threat of investing passive index. Nevertheless, there is opposition to market efficiency theory based on an empirical and theoretical basis. Some investors have access to the market by focusing on undervalued stocks. Through specific skills, some investors can outperform markets based on probability laws. Markets have multiple actors that influence them, where some will cause some underperformance, while others outperform the average.

Part 2

Random walk theory identifies that stock prices changes are independent, and their distribution is unique. The assumption matches the market efficiency theory by identifying that past stock trend does not predict the future movement. The theory identifies that stocks movement is random and takes unpredictable paths (Michael, 2014). Such unpredictability makes it relatively futile for investors to focus on future stock prices. Investors find it challenging to outperform market prices while ignoring possible additional risks (Michael, 2014). Therefore, maintaining price trends is relatively challenging due to the inability to select exit and entry equity investments. The three major market efficiency types include weak, semi-market efficiency, and strong efficiency.

Weak form efficiency basis on the identification that securities prices are not a reflection of publicly available market data. There is the assumption that past data relating to returns, volume, and price are independent of future market prices. Semi-strong form dismisses fundamental and technical analysis. The assumption is that market price adjustment has predictive power that matches future price paths (AnalystPrep, 2019). The strong form holds prices as a reflection of private and public information. The market efficiency type that is likely to exist presently is strong EMH because it highlights the role of different factors in influencing share prices. From my experience, I have found that factors such inflation, economic stability, and purchasing power influence the direction of stock price. Ikechukwu et al. (2020), notes that factors beyond investors’ manipulation, result in sustainable market prices that can neither be undervalued nor overvalued. Ang et al. (2011) agree that trying to beat the market through speculation is unworthy to investors due to variables that play a role in influencing stock price. Therefore, strong efficient market hypothesis takes precedence over the others due to its accurate prediction of market price dynamics.