Question

a)Which of the following strategies violate all three forms of the Efficient Market Hypothesis?

[I] Buying companies that have a name starting with letter “A” and shorting companies that have a name starting with letter “Z” consistently generate abnormal profits for investors.

[II] Buying companies that announce positive accounting profits and shorting companies that announce negative account profits consistently generate abnormal profits for investors.

b)Post Earnings Announcement Drift (PEAD) is NOT a violation of which form(s) of the Efficient Market Hypothesis?

		Weak form only
		Semi-strong form
		Strong form
		It violates all three forms

Answer 1

(a) (1) violates all three forms of Efficient Market Hypothesis.

EMH includes three forms:Weak form-disregards technical analysis

Semi strong form -disregards fundamental analysis

Strong form-disregards insider trading.

When a person is making abnormal profits by just looking at the name of the stock he is clearly violating all three forms of EMH.Profit is made without even using fundemental analysis which means all three forms are violated.

In the second case weak form of EMH is supported as the person is making profits by fundamental analysis which automatically violates semi strong form and strong form.

b)Weak form only.

PEAD is defined as continuous drift of prices in a specific direction after announcement of result by a company.Making profits using PEAD can be considered as a form of fundamental analysis since newly published information is used to generate profits.

Therefore weak form of EMH is not violated as fundamental analysis is used to create profits.Semi strong and Strong forms are violated because both disregard fundamental analysis.