The Contrasting Evidence of the Validity of Efficient Market Hypothesis Essay Example

in the market. On the other hand, the strong form of efficiency, as its name suggests, asserts that the current price of a stock incorporates all information available in the market, including both private and public information. In this case, insider information cannot provide any benefit to the investor. Economists who support the efficient market theory (EMT) strongly believe in market efficiency. They argue that markets can remain efficient even if many participants in the market are irrational.

Additionally, economists argue that markets can remain efficient despite increased volatility in stock prices. Economists view markets as effective systems that efficiently process and distribute new and accurate information. In his book, A Random Walk Down Wall Street, Burton Malkiel comically illustrates this concept by comparing it to a blindfolded chimpanzee randomly selecting stocks from the Wall Street Journal with the same success rate as financial experts. Benjamin Graham (1965) also suggested that the stock market functions as a voting mechanism in the short term but transitions into a weighing mechanism in the long term. The performance of investment analysts and mutual funds further supports the notion of market efficiency.

The investors on Wall Street analyzed their performance in relation to randomly chosen stocks, referred to as the "Investment Dartboard." They discovered that at times the board outperformed them while other times they surpassed it. Similarly, mutual funds that achieved better market performance in one period did not sustain this success in the subsequent period. Nevertheless, it is believed that ultimately, genuine value will always prevail. The Efficient Market Theory (EMT) asserts that markets are fairly priced, making it impossible for investors to take advantage

of the market and earn excessive returns.

Economists explain the occurrence of market bubbles and crashes as market mispricing rather than market inefficiency. Critics of the Efficient Market Hypothesis often refer to Robert Shiller's criticism, who famously called it "one of the most remarkable errors in the history of economic thought." Another prominent opponent of EMH is Warren Buffet, who humorously stated that "I'd be a bum on the street with a tin cup if the market was always efficient." EMH faces criticism due to recent financial bubbles and crashes that provide evidence of the market being influenced by fads, whims, and anomalies, thus highlighting its inefficiency.

EMH posits that while all the information is accessible to investors, not all investors behave rationally or make rational investment choices. Warren Buffet and Benjamin Graham are examples of investors who have consistently outperformed the market by adhering to the value discipline, purchasing stocks at prices lower than their intrinsic value. The criticism against EMH is bolstered by the "small firm effect," which demonstrates that numerous small companies have achieved significantly higher returns over extended periods of time, despite the higher risk involved.

The efficient market hypothesis has been greatly challenged by the small firm effect. Another anomaly that contradicts the random walk theory is the "January effect," which reveals abnormal price rises in stock prices from December to January. These facts have raised doubts among academics, leading them to develop and test numerous theories to assess market efficiency or inefficiency.

The market's efficiency is somewhat true, but evidence shows that investors like Warren Buffet consistently outperform it, proving that beating the market is

possible. Irrational investment decisions and excessive volatility influence stock prices, resulting in market inefficiency.