The Efficient Market Hypothesis and Michael Jensen Arguments



Numerous papers have demonstrated that early identification of new information can provide substantial profits. Insiders who trade on the basis of privileged information can, therefore, make excess returns, violating the strong form of the efficient market hypothesis. Even the earliest studies by Cowles (1933,1944), however, make it clear that investment professionals do not beat the market. It has already been stated that an efficient market is one where the prices of securities fully reflect all available information, but then what are the sufficient conditions for capital market efficiency? Michael Jensen (1978) arguments were built on the above assumptions which today, many researchers have raised eyebrows to the validity of this statement. In this direction, the debate about market efficiency has resulted in thousands of empirical studies and literature attempting to determine whether particular markets are in fact ‘efficient’, and if so to what degree. In fact, the majority of studies and researches of technical theories have gone to the result that it is difficult to predict prices. No wonder, Neale &amp. McElroy (2004) were less categorical and stated that “sometimes stock market valuations may look irrational. But in the longer term, the markets are efficient processors of information and get valuation about right” In addition, the random walk theory indicates that price movements will not follow any trends and so by knowing the past price movements it’s not possible to predict the future price movements. All these states that markets are in fact efficient. However, researchers have also exposed many stock market anomalies that seem to be inconsistent with the efficient market hypothesis. This section attempts an analysis of Michael Jensen 1978 arguments on the efficient market hypothesis. An attempt was also made to reconcile this statement with Neale &amp. McElroy 2004 statement. From the above analysis, one can gently conclude that trading strategies seem to be widespread among fund managers and there is little evidence that they would generate excess returns in practice (Malkiel, 2003). Researchers have also exposed many stock market anomalies that seem to be inconsistent with the efficient market hypothesis. The end of the year effect, the small firm effect is all good examples of this effect. The efficient market hypothesis has been challenged by numerous studies on the grounds that there are often underreaction or overreaction of stock markets to information. (Baberies et al, 1998. Daniel et al, 1998. Hong and Stein, 1999). Accordingly, in a variety of markets, sophisticated investors can earn superior or riskless profits by taking advantage of market imperfections (underreaction or overreaction). The capital asset pricing model (CAPM) is a model that establishes the equilibrium relationship between the risk and return on a risky asset. (Bodie et al., 2005).