CORPORATE FINANCE AND CORPORATE GOVERNANCE IN CHINA
EMH efficient market hypothesis
What is the efficient market hypothesis?
This hypothesis talk about asset market that have good regulation, good market maker and that have a lot of depth and liquidity. The main assumption of this study is that in these markets the prices are perfect indicators of the true value.
THE MARKET EFFICENTLY INCORPORATE ALL INFORMATION, and the prices are the best information about the value of something.
In other words, the efficient market hypothesis is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.
The first that talked about EMH was George Gibson, author of “ the stock exchanges of London, Paris and New York” in 1889.
He believed in the efficient market and his thought was that “when shares become publicly known in a open market the value which they acquire there, may be regarded as the judgment of the best intelligence concerning them”.
Nowadays the idea is that the only way to beat the market is not just get information as soon as they are out but also to have information that nobody else has.
Investors now can improve their access to the information and throw that try to be the first to beat the market as soon as a new information is out.
EMH become popular 1970 and was view as an evolution of the “random walk theory”.
The random walk theory says that under efficient market stock prices and other speculative asset prices are random walks, just because market response only to new information that are unforecastable. There is no way to predict the market.
The efficient market hypothesis has informed a lot of regulation. “The security and exchange commission” and other agencies that regulate financial market have shown some faith in the efficient markets hypothesis. The feeling is that maybe their primary mission is to regulate the flow of information, to make sure that everyone has access to information on the same time.
For example, the Security for Exchange Commission required that when a corporation publishes information that are relevant for the value of their stock they have to put them out to everyone at once.
How to define the efficient market?
In 1967 Harry Roberts from the university of Chicago gave three definition of EMH:
WEAK FORM only the information of past prices are already incorporated into price
SEMI-STRONG FORM market prices incorporated all public information
STRONG FORM all information whether public or not is incorporated into price.
Those three definitions differ in terms of the amount of information that are efficiently incorporated into prices.
But what means that prices incorporate information?
The easiest explanation is that the PRICES are the EXPECTED PRESENT VALUE OF FURURE DIVIDENDS PAID ON STOCK.
The EMH says that the true value of a stock comes from the dividends that it pays, that is a cash flow that is valued by the market, and the market values it as the present value of the optimally forecasted future dividends.
The formula for the present value for calculate the price of a stock is : P=Dividend/(r-g)
The price at time “t” is the expectation of the dividend at time “t+k” discounted by a discount factor r.
That mean that the price is a forecast of future dividends to be paid on the stock, price is related