Market efficiency hypothesis

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The efficient-market hypothesis (Engl. Efficient market hypothesis ), short EMH, is a mathematical-statistical theory of finance . The EMH states that asset prices reflect all available information. A direct consequence is that no market participant can beat the market in the long term. Asset prices should only respond to new information and therefore a random course (random walk) have.

Bachelier (1900), Samuelson (1965) and above all Eugene Fama made significant contributions to the EMH . In 1970, he systematized the essential theoretical and empirical research results in an influential review paper . In addition, Fama operationalized the EMH for the first time and provided a series of empirical tests. The EMH can only be formulated together with a risk model (network hypothesis ). Financial economics has therefore been investigating market anomalies, i.e. deviations from the specified asset pricing or risk model, since the 1980s. As a rule, these are deviations from the CAPM .

The EMH provides a theoretical basis for modern portfolio theory . In addition, EMH forms the foundation for passive investing with index funds .

In 2013, Eugene Fama, together with Robert J. Shiller and Lars Peter Hansen, were awarded the Alfred Nobel Memorial Prize for Economics for their work on the efficiency of markets (or “for their empirical analysis of asset prices”) .

Historical background

The observation that share prices have a random walk was first shown in 1900 by the French mathematician Louis Bachelier . However, economic historians have found an even earlier representative of the random walk theory in Jules Regnault . Bachelier's work has been cited by various mathematicians such as Joseph L. Doob , William Feller, and Andrey Kolmogorov .

In 1940 Friedrich August von Hayek argued that markets would be the most efficient way to aggregate the dispersed information in a society. The possibility of benefiting from private information would create a great incentive for market participants to use this information for transactions. In this way, market participants would ensure more efficient market prices.

In the 1960s, interest in EMH continued to grow, as it was now possible to use computers to compare many stock prices quickly and efficiently. Bachelier's dissertation was republished. In 1965 Eugene Fama published his dissertation in which he presented statistical-empirical studies of the random walk theory. In the same year Paul Samuelson presented a mathematical proof that prices in efficient markets must follow a random walk. Therefore there is a very close connection between EMH and random walk theory. Samuelson's evidence, along with the empirically observed random walk of stock prices, is often cited as an argument in favor of the EMH. But this is a logical fallacy. From the empirically observed random courses, it cannot be concluded that stock markets are therefore efficient. Samuelson himself points this out at the end of his proof: "From a nonempirical base of axioms you never get empirical results." (You never get empirical results from a non-empirical axiomatic basis.) In 1970 Eugene Fama published a study in which he systematized both the theoretical basis and the empirical research on EMH. In addition, Fama's study specified and expanded the theoretical basis and presented empirically verifiable tests for the EMH.

Basics

The market efficiency hypothesis states that the prices achieved in a market reflect all the information that is available in that market.

This is equivalent to saying that the market has rational expectations . A rational expectation does not necessarily mean that the majority of market participants must be rational (or even just informed), but only that the overall assessment (expected value) of the market participants is rational.

In a market where you can always buy / sell at prices that reflect all the information, you can assume that you will never buy too expensive and never sell too cheap. As a consequence, it would also follow: “Nobody can expect to achieve permanently higher profits than the market (average)”.

The application of the market efficiency hypothesis generally only relates to capital markets. Information on companies, countries and raw materials leads to consequences in the prices just seconds after becoming known, which is an indication that the prices very quickly represent the level of information on the market.

Traditional markets (weekly market, supermarket, retail, wholesale) are generally seen as inefficient. One reason for this is that the buyer usually has a considerable information deficit vis-à-vis the seller and that a trade is not always made with the intention of making a profit (but rather with the intention of consuming, for example).

Operationalization

Eugene Fama operationalized the EMH for the first time . To this end, he presented 3 degrees of market efficiency and presented empirical tests. This relates to the core message of EMH, namely that prices reflect all available information. The 3 grades specify what exactly is meant by "all available information". That is, they state what the amount of information available represents.

Weak EMH

The weak form of the EMH assumes that all historical price developments are priced in. It follows from this that the price developments in the past cannot be used to infer prices in the present and future. If this variant of efficiency is available, technical analysis should not be able to achieve an information advantage.

Medium strict EMH

The medium-strict form of the EMH assumes that, in addition to the information of the weak EMH, all other public information is also priced in. This includes, for example, business reports , annual financial statements , economic indicators and securities analyzes by financial analysts . Fundamental analysis would therefore be pointless because all publicly available information has already been priced in.

Strict EMH

The strict form of the EMH assumes that all market-relevant information is included in the course. This includes all public and inside information. Accordingly, insider trading would be impossible.

Compound hypothesis

In empirical reviews of the EMH, Fama points out the composite hypothesis problem. It is not possible to test the market efficiency hypothesis without specifying an asset pricing model at the same time. Anomalies can then be explained either by market inefficiencies or an incorrect asset pricing model. According to Fama, the EMH cannot therefore be tested per se. Because a test of the market efficiency hypothesis is also a test of the underlying asset pricing model.

Empirical review

  • Empirical tests of the weak efficiency showed that this is the case in reality. A serial correlation of prices exists at most for a short time, a systematic exploitation of information does not take place due to the transaction costs.
  • Empirical studies on the moderate efficiency tend to be confirmed. However, due to methodological problems, these results should be treated with caution.
  • There is broad consensus in the literature that high efficiency does not occur in reality. When important information is published, significant price changes can be regularly observed on the stock exchanges; the information cannot have been priced in beforehand.

Investigations by American mutual funds came to the conclusion that the majority of these actively managed investment funds do not provide any systematic excess return compared to a market-neutral portfolio. This can be explained in the context of the EMH and is predicted by it. When the higher costs of these funds are deducted, on average they offer no added value compared to passive index funds .

In empirical tests of the EMH were anomalies found such. B. Calendar anomalies (“ January effect ”), overreactions and underreactions and longer periods of exaggeration ( speculative bubbles ). However, such anomalies are opportunities for arbitrage business. The January Effect disappeared very quickly after its publication.

Anomalies relevant to research that pose a problem for EMH or the classic CAPM asset pricing model are, for example, size and value premium. This means the systematic excess return of small companies (size), or companies valued cheaply, relative to a fundamental company parameter (value). Eugene Fama and Kenneth French were able to explain these anomalies in the context of the EMH by modifying the asset pricing model by introducing a three-factor model which traces equity loans back to 3 statistically independent risk factors.

Opinions on the market efficiency hypothesis

Since the late 1970s, the market efficiency hypothesis has been increasingly questioned. Alternative explanations for explaining market movements are represented by Robert J. Shiller, Paul Krugman , Daniel Kahneman, Amos Tversky and Richard Thaler.

“It should be obvious to the most casual and unsophisticated observer by volatility arguments like those made here that the efficient markets model must be wrong ... The failure of the efficient markets model is thus so dramatic that it would seem impossible to attribute the failure to such things as data errors, price index problems, or changes in tax law. "

“For the casual and honest observer, because of the volatility arguments such as those presented here, it should be clear that the market efficiency hypothesis must be wrong ... The failure of the market efficiency hypothesis model is so dramatic that it seems impossible, the failure of such things as data errors, problems with the price index or changes in tax law. "

- Robert J. Shiller , 1981

Paul Samuelson described stock markets as "micro-efficient" but "macro inefficient". This means that EMH describes the behavior of individual stocks much better than the behavior of the stock market as a whole.

Sanford J. Grossmann and Joseph E. Stiglitz have shown that fully efficient markets are impossible because information comes with a cost. Those market participants who bear these costs receive no compensation in efficient markets, which is why the liquidity of efficient markets is zero. Hence, markets cannot be completely efficient. This fact is also known as the Grossmann-Stiglitz paradox.

See also

literature

  • EF Fama: Efficient Capital Markets, A Review of Theory and Empirical Work. In: Journal of Finance. Volume 25, 1970, pp. 383-417.
  • Burton G. Malkiel: A Random Walk Down Wall Street. WWNorton and Company, 2007, ISBN 0-393-06245-7 .
  • T. Gudehus: 5.10 Market efficiency and self-regulation. In: Dynamic markets, practice, strategies and benefits for business and society. Springer, Berlin / Heidelberg / New-York 2007, ISBN 978-3-540-72597-8 , p. 113 ff.

Individual evidence

  1. ↑ a b c d e f g h i j k l m n o E. F. Fama: Efficient Capital Markets, A Review of Theory and Empirical Work. In: Journal of Finance. Volume 25, 1970, pp. 383-417.
  2. ↑ a b Davis, Mark .: Louis Bachelier's Theory of Speculation: the Origins of Modern Finance. Princeton University Press, 2011, ISBN 978-1-4008-2930-9 .
  3. ^ A b c Samuelson, Paul A .: Proof that properly anticipated prices fluctuate randomly . [sn] ( Online [accessed July 6, 2020]).
  4. ^ A b E. F. Fama: Efficient Capital Markets II. In: Journal of Finance. Volume 46, No. 5, 1991, pp. 1575-1617.
  5. ↑ G. William Schwert: Chapter 15 Anomalies and market efficiency . In: Handbook of the Economics of Finance . tape 1 . Elsevier, 2003, ISBN 978-0-444-51363-2 , pp. 939-974 , doi : 10.1016 / s1574-0102 (03) 01024-0 .
  6. ^ A b Eugene F. Fama, Kenneth R. French: The Cross-Section of Expected Stock Returns . In: The Journal of Finance . tape 47 , no. 2 , June 1992, pp. 427-465 , doi : 10.1111 / j.1540-6261.1992.tb04398.x .
  7. ^ Elton, Edwin J., Elton, Edwin J .: Modern portfolio theory and investment analysis . 6th ed. J. Wiley & Sons, New York 2003, ISBN 0-471-23854-6 .
  8. ^ Reilly, Frank K., author .: Investment Analysis & Portfolio Management . ISBN 978-0-17-041603-0 , pp. 186 ( online [accessed July 5, 2020]).
  9. ↑ Patrick Bernau: Eugene Fama: The market knows everything . In: FAZ.NET . ISSN  0174-4909 ( Online [accessed July 9, 2020]).
  10. ^ Nobel Committee
  11. ^ A b Franck Jovanovic: Bachelier: Not the forgotten forerunner he has been depicted as. An analysis of the dissemination of Louis Bachelier's work in economics . In: The European Journal of the History of Economic Thought . tape 19 , no. 3 , June 2012, ISSN  0967-2567 , p. 431–451 , doi : 10.1080 / 09672567.2010.540343 .
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  13. ^ FA Hayek: The Use of Knowledge in Society . In: The American Economic Review . tape 35 , no. 4 , 1945, ISSN  0002-8282 , pp. 519-530 , JSTOR : 1809376 .
  14. ^ A b Read, Colin, 1959-: The efficient market hypothesists: Bachelier, Samuelson, Fama, Ross, Tobin and Shiller . ISBN 978-0-230-27421-1 .
  15. ↑ Cootner, Paul H., editor .: The random character of stock market prices . Risk, 2000, ISBN 1-899332-84-7 (© 1964).
  16. ^ EF Fama: The Behavior of Stock Market Prices. In: Journal of Business. Volume 38, 1965, pp. 34-105.
  17. ↑ EF Fama: Random Walks in Stock Market Prices. In: Financial Analysts Journal. Volume 21, 1965, pp. 55-59.
  18. ^ Burton G. Malkiel: Random Walk down Wall Street . WWNorton and Company, 2007, ISBN 0-393-06245-7 , pp. 246 .
  19. ^ A b Prof Dr Wolfgang Breuer: Definition: efficiency of the capital market. Accessed July 30, 2020 .
  20. ^ A b c Manfred Steiner, Christoph Bruns: Securities management: professional securities analysis and portfolio structuring . 8., revised. and exp. Edition. Schäffer-Poeschel, Stuttgart 2002, ISBN 3-7910-1992-9 , p. 41 ff .
  21. ^ Bertram Scheufele, Alexander Haas: Media and shares. VS Verlag für Sozialwissenschaften, 2008, ISBN 978-3-531-15751-1 , p. 27.
  22. ↑ a b c Michael Heun: Financial market simulation with multi-agent systems. Deutscher Universitäts-Verlag, 2007, ISBN 978-3-8350-0937-0 , p. 95.
  23. ^ A b Eugene F. Fama, Kenneth R. French: Luck versus Skill in the Cross-Section of Mutual Fund Returns . In: The Journal of Finance . tape 65 , no. 5 , 2010, ISSN  1540-6261 , p. 1915–1947 , doi : 10.1111 / j.1540-6261.2010.01598.x .
  24. ^ Alan Crane, Kevin Crotty: How Skilled Are Security Analysts? In: The Journal of Finance . tape 75 , no. 3 , June 2020, ISSN  0022-1082 , p. 1629-1675 , doi : 10.1111 / jofi.12890 .
  25. ↑ Jonathan Berk, Richard Green: Mutual Fund Flows and Performance in Rational Markets . National Bureau of Economic Research, Cambridge, MA October 2002, doi : 10.3386 / w9275 .
  26. ^ A b Ann-Christine Schulz: The role of financial analysts in the dissemination of management concepts. Gabler Verlag, 2011, ISBN 978-3-8349-3016-3 , p. 55.
  27. ↑ Christian Christen: Political Economy of Old Age Security - Critique of the reform debate about intergenerational equity, demography and funded financing. Metropolis-Verlag, Marburg 2011, p. 398.
  28. ^ Burton G. Malkiel: The Efficient Market Hypothesis and Its Critics . In: Journal of Economic Perspectives . tape 17 , no. 1 , February 1, 2003, ISSN  0895-3309 , p. 59-82 , doi : 10.1257 / 089533003321164958 .
  29. ^ Rolf W. Banz: The relationship between return and market value of common stocks . In: Journal of Financial Economics . tape 9 , no. 1 , March 1, 1981, ISSN  0304-405X , p. 3-18 , doi : 10.1016 / 0304-405X (81) 90018-0 .
  30. ^ Barr Rosenberg, Kenneth Reid, Ronald Lanstein: Persuasive evidence of market inefficiency . In: The Journal of Portfolio Management . tape 11 , no. 3 , April 30, 1985, ISSN  0095-4918 , pp. 9-16 , doi : 10.3905 / jpm.1985.409007 .
  31. ^ Eugene F. Fama, Kenneth R. French: Common risk factors in the returns on stocks and bonds . In: Journal of Financial Economics . tape 33 , no. 1 , February 1, 1993, ISSN  0304-405X , p. 3-56 , doi : 10.1016 / 0304-405X (93) 90023-5 .
  32. ↑ Jeeman Jung, Robert J. Shiller: Samuelson's Dictum and the Stock Market . In: Economic Inquiry . tape 43 , no. 2 , 2005, ISSN  1465-7295 , p. 221-228 , doi : 10.1093 / ei / cbi015 .
  33. ^ Sanford J. Grossman, Joseph E. Stiglitz: On the Impossibility of Informationally Efficient Markets . In: The American Economic Review . tape 70 , no. 3 , 1980, ISSN  0002-8282 , pp. 393-408 , JSTOR : 1805228 .
  34. ^ Matt Levine: Good Investors Make Investing Harder. In: Bloomberg News. July 3, 2019, accessed on July 5, 2020 .