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Market inefficiencies

Several papers have focused exclusively on developed stock markets and a few emerging markets in Asia, Europe, and Latin America. One questions whether these markets provide an avenue for investors seeking diversification and investors’ potential returns over time to the changing risk patterns in these equity markets. There is substantial diversity among the world’s emerging markets in terms of infrastructure, market size, and liquidity.

Some investors believe that emerging markets in Eastern Europe have greater growth potential over the next decade compared to the emerging markets of Asia and Latin America. Investors may view European emerging markets as better quality than what is available in Asia or Latin America because the infrastructure and regulations of Eastern Europe are closer to that of developed markets. Furthermore, the high education levels in Eastern Europe, combined with lower salary levels compared to the developed world, make direct foreign investments and outsourcing production favourable.

The question remains – how fluid is the market, and can information (or education) offer an investor an edge over his or her counterparts? In considering the past, present and future of EMH in securities exchange, this study seeks to examine the United Kingdom and its own stock market. This study will

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observe movements and significant memory trends in the FTSE 100, a share index listing the 100 most capitalized companies, and AIM, the Alternative Investments Market, which allows smaller companies to float shares within the index in a more flexible regulatory system than is common.

Both indexes are within the London Stock Exchange. ? In light of the literature reviewed, this study will encompass two hypotheses. The first is that there are latent differences in information processing between lined markets. The expectation being that AIM listed companies will be subject to less scrutiny by market participants than their FTSE counterparts and more prone to information inefficiencies. Therefore, their share prices should inherently exhibit long memory.

The second hypothesis is the relative size hypothesis. Larger companies should be subject to greater scrutiny by market participants and therefore less prone to market inefficiencies. The tendency towards long memory should thus be more prominent in smaller companies.  In predicting the behaviour of stocks on the securities exchange, considerations such as interest rates, inflation, dividend yield (Dt/Pt? 1), price earnings ratio, output growth, and term premium must all be considered.

The level of understanding of these points, and instinctual knowledge of the market in general, could possibly give investors that are more intelligent the ability to read the market and forecast future earnings. A weak form efficiency in the market suggests that the current share price on a given stock market exchange fully reflects the information implicit in the share price history of a company, the implication being that the share price time series does not exhibit serial correlation.

Recently, a large number of studies in the finance literature have confirmed that stock return prediction is feasible to some degree by means of interest rates, dividend yields and a variety of macroeconomic variables exhibiting clear business cycle variations. While the vast majority of these studies have looked at the US stock market, emerging literature has also considered the United Kingdom stock market.

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