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UK Stock Market Essay

The Efficient Market Hypothesis (EMH) states that at any given time, security prices fully reflect all available information. This means that all people “playing the market” are not doing anything that requires skill, but rather playing at a game of chance. Many books have been published inviting common people to become the next millionaire using certain stock market strategies. This is in contrast to the theory behind EMH. This study looks at 50 companies listed in the London Main (FTSE 100) and Alternative Investments Market (AIM) to investigate the possibility of weak form efficiency in these markets.

In attempting to describe the time-series behaviour of these markets in terms of fractional representation, this paper uses random field based tests as well as traditional tests. The Efficient Market Hypothesis (EMH), delineated in 1960 by Eugene Fama, states that no single investor can win at the market using any piece of information known to all others. No amount of knowledge, aside from insider trading, can offer insight to the performance of a companies stock on the market. Fama’s theory further decomposes into three levels of efficiency: strong, semi-strong and weak.

The strong form suggests that securities prices reflect all available information, even private information.

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This subheading of EMH poses that insiders profit from trading on information not already incorporated into prices. Hence, the strong form does not hold in a world with an uneven playing field. The semi-strong form of EMH asserts that security prices reflect all publicly available information. There are no undervalued or overvalued securities and thus, trading rules are incapable of producing superior returns.

The release of new information incorporates into the price rather speedily. The weak form of the hypothesis suggests that past prices or returns reflect future prices or returns. The inconsistent performance of technical analysts suggests this form holds. However, Fama (1991) expanded the concept of the weak form to include predicting future returns with the use of accounting or macroeconomic variables. The evidence of predictability of returns provides an argument against the weak form.

While the semi-strong form of EMH has formed the basis for most empirical research, recent research has expanded the tests of market efficiency to include the weak form of EMH. There continues to be disagreement on the degree of market efficiency. Within global security markets, the main challenge for both investors and policy makers is to take advantage of and promote efficiency enhancing aspects of market interaction, while containing and controlling the undesirable destabilising effects.

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