Question

r the following questions on cfficient market hypothesis (EMIH) If the markct is weak-form efficient, explain whether investors can use (a) publicly available information to make abnormal returns. (b) If the market is strong-form efficient, explain whether investors can use fundamental analysis to generate abnormal returns. c) A famous cconomist just announced in the newspapers his findings that the expansion is over and the Hong Kong economy is again entering a recession. Assume the Hong Kong stock market is efficient. Discuss whether you can profit from selling short the Tracker Fund of Hong Kong after you read this announcement (d) Armold made superior returns by buying Tracker Fund of Hong Kong when 10-day moving average line crosses over 50-day moving average line in up markets and selling Tracker Fund of Hong Kong when 50-day moving average line crosses under 10-day moving average line in down markets. Explain whether this is a violation of the weak form of market efficiency.

Answer 1

a. Under random walk theory it is not possible to use public information to make abnormal returns as it considers the price movement to be random and states that any movement in the price of the stock could not be estimated as the prices move in a random fashion. So any information will not have any effect on the prices of the stock.

b. No, it won't be possible for the investor to gain abnormal returns with the help of fundamental analysis under strong form of efficiency as the theory states that any information be it public or private is reflected in the current market price and the best estimate whatever the information may be. Therefore, the investor will not be able to gain anything more than the normal returns.

c. No, one would not be able to make profit by short selling on the information as the theory states that market is efficient enough to reflect effect of any information immediately therefore by the time one trades the prices would reflect the information publishedin the newspaper thereby reducing the chances of making profit through market trading.

d. The process through which Arnold made profit is known as technical analysis and it is a violation of weak form of market efficiency as under its conditions, it wouldn't have been possible for Arnold to make profit by analysis as thr prices move randomly and it is almost impossible to estimate the future market trend(which was done by Arnold). However, the theory states that any profit made in such a fashion could be attributed to chance factors.