Weak form EMH

Part B

Considering essence and the content of risk already there is no need to prove that the success of the businessman or manager substantially depends on understanding of the attitude towards risk.

The risk in portfolio construction and management has quite independent theoretical applied value as an important component of the theory and practice of management.

The analysis of the economic literature devoted to a risk problem shows that among researchers there is no consensus concerning definition of investment risk. For today there is no unambiguous understanding of essence of risk. It is explained by a huge amount of the aspects of this phenomenon, almost full ignoring it by economic legislation in real economic practice and an administrative management

The analysis of numerous definitions of risk allows revealing the main points which are characteristic for a risk situation, such as:

· Uncertainty existence

· Existence of alternative decisions

· Probability of outcomes and the expected results

· Probability of emergence of losses

· Probability of receiving additional profit

For understanding of the nature of portfolio construction and management risk fundamental value has link between risk and profit. A fund manager or an investor shows readiness to take the risk in the conditions of uncertainty as along with risk of losses there is a possibility of the additional income. Though it is clear that receiving profit isn't guaranteed to the fund manager or investor, remuneration for the spent time, efforts and abilities can appear as either profit or losses.

In the figure 1.1 it is shown the link between risk and return and the types of investments on the line from less risky to highly risky.

Figure 1.1

It is possible to choose the decision containing less risk, for example Bonds, but thus there will be also less return, and at highest (Small-Cap Equity Core) the return has the highest value. However Ben Graham (1949) states that it is unconventional to speak of good bonds as less risky than good preferred stocks. He stated that people believe that stocks are not safe, whereas the bond is clearly proved unsafe when it defaults its interest or principal payments. Nevertheless, the bond’s risk of default is much lesser than the stock price’s risk of going down.

On the other hand, most common stocks do involve risks of such deterioration. But it is our thesis that a properly executed group investment in common stock does not carry any substantial risk of this sort and that therefore it should not be termed “risky” merely because of the element of price fluctuation (Ben Graham, 1949). In other words, the thorough analysis in the securities selection, management or portfolio construction will make the “business” carry less risk

Functions of investment risk allow making a conclusion that, despite the considerable potential of losses which bears in it risk, it is a source of possible profit. Therefore the main objective of the fund manager or investor is not refusal of risk in general, but the decision making connected with risk on the basis of objective criteria namely: to what limits the fund manager or the investor can act, taking the risk.

Note that existence of risk as integral element of economic process, and also specifics of the administrative influences used in this sphere led to that risk management in some cases began to act as an independent type of professional activity

Part C

The EMH was introduced by Professor Eugene Fama in 1965. The efficient market hypothesis (EMH) assumes that any new information not simply arrives on the market, but does it very quickly – almost instantly it finds reflection in price level. Therefore equality of market price of an action of its internal cost is observed at any moment. In such conditions becomes impossible "to outwit" the market that is to buy the security cheaper or to sell more expensive than its valid (fair, internal) costs. Its other definition is based on the property of absolutely effective market: the market is considered absolutely effective in relation to certain information if, using this information, it is impossible to make the decision on purchase or sale of securities allowing receiving excess profit.

Usually allocate three forms of efficiency of securities market:

First form is a weak-form EMH. The market is poorly effective, if the prices completely reflect all information containing in the last prices. I.e. Weak the form of efficiency of the market claims that in the prices of stocks the information which can be received, is already reflected, analyzing such data, as data on their prices in the past, volumes of their purchase and sale or the number of actions necessary for the covering of the transactions made earlier without covering. Bodie, Kane and Marcus claim that this version of a hypothesis assumes uselessness of implementation of the analysis of tendencies. Data about the past prices are public and it can be received practically free of charge. If such data bore in themselves reliable signals of future behavior of the prices, all investors would manage to use them long ago. Eventually these signals lose the value as soon as becomes widely known as, for example, the signal of purchase immediately conducts to an advance in price.

The semi-strong EMH form claims that all of the public information concerning prospects of any particular firm has to find reflection in the price of its stocks. Such information includes the past stock prices, fundamental data on the nomenclature of relevant firm production, quality of its management, structure of the balance sheet, the owned patents, projected income, methods of conducting accounting, etc. As well as in the previous case if any investor can receive this information from public sources, it is possible to assume that it will be to be considered in the price of stocks.

The strong form of EMH claims that the prices of shares reflect all information relating to the relevant firm in that number and available only to the staff of this firm. I.e. price of the security is equal to its investment cost, and the market is absolutely effective. Absolutely effective market is that market, on which the price of each security is always equal to its investment costs

The following articles will be reviewed in order to prove or disapprove the forms of EMH:

· “Testing the Weak-form Efficiency Market Hypothesis:Evidence from Nigerian Stock Market” by Victor K. Gimba

· “Efficiency Hypothesis of the Stock Markets: A Case of Indian Securities” by Gagan Deep Sharma and Mandeep Mahendru

· “Testing Semi-Strong Form Efficiency and the PEAD Anomaly in ATHEX. An Event Study based on Annual Earnings Announcements” by Stavros I. Derdas

· “Efficient Markets Hypothesis” by Andrew W. Lo, the student of Massachusetts Institute of Technology

Article 1

The data, found by Author, consist of daily (Mookerjee and Yu, 1999; Cheung and Coutts, 2001; Groenewold et al., 2003, Lima and Tabak, 2004 and Seddighi and Nian, 2004), weekly (Dickinson and Muragu, 1994; Dockery and Vergari, 1997; Abraham et al., 2002; and), monthly Sharma and Kennedy, 1977; Barnes, 1986; Fawson et al., 1996; Olowe, 1999; Karemera et al., 1999; and Alam et al., 1999) and even yearly time series (Chang and Ting, 2000). The findings showed that the null hypothesis (weak-form EMH is applicable) is rejected. Nevertheless the Author made his own calculations and research on his hypothesis and rejected it also. The Author selected the Nigerian stock Index (NSINDEX) and 5 stocks (FIRSTB, UBA, UNIONB, CADBURY, NESTLE) for his research. From the 4.2 Results for daily returns we can see that the returns have not reached the expectancy level, the Q-test failed to support the joint null hypothesis that all autocorrelation coefficients of 12 lags are equal to zero for all individual stocks. Also the empirical results for the correlated returns again rejected the “Random Walk” hypothesis for the Index and all individual stocks. The weekly results show the same for the autocorrelation test. Also the null hypothesis is rejected in Variance Ratio tests.

Article 2

Weak form EMH

Serial correlation test for this approach was performed in daily return by Schwartz and Whitcomb (1977a, 1977b) and Rosenberg and Rudd (1982), who found that the first order serial correlation of daily return residual from the market model is small but significantly negative.

Filter tests showed that no abnormal returns was generated.The evidence shows that the filter size is irrelevant; the reason of it is no filter rule can generate excess returns over a “Buy and Hold” strategy. This approach was investigated by Alexander (1961), and Fama (1965), who found that no abnormal return was generated.

Volatility tests assume that the expected returns are constant and the variation in stock prices is driven entirely by shocks to expected dividends” (Fama, 1991). Grossman and Shiller (1981) attempt to use volatility testing to examine whether the variation in expected return is rational or not. The results showed that the variation in expected returns was irrational.

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