Finance and Financial Markets Essay Example | Topics and Well Written Essays - 2000 words

Finance and Financial Markets - Essay Example The supporters of efficient capital market theory claim that the stock prices are efficient enough to fully represent information. But, the efficient capital market theory remains silent when the median revenue before the 1987 crash were $18.6 million, and right after the two years of crash, the median revenue increased to $34.7 million. Before the market crash of 1987, the standard deviation of revenue was $276 million, but after two years of crash, the standard deviation of revenue increased to the level of $327 million. On the one hand, capital markets crashed; on the other hand, the median revenue and standard revenue were steadily increasing. In this paper, a critical evaluation of efficient capital market theory is carried out in the following parts of the essay. Besides, types of capital markets, technical analysis and fundamental analysis are incorporated into this piece of writing. Definition An efficient capital market is such type of stock market where the current stock pr ices fully reflect information, including the information of risk (Schweser, 2004). In the year of 1970, Eugene Fama (1970) introduced the concept of ‘Efficient Capital Markets’. In which, efficient capital markets are clearly defined. ... And, this theory is less relevant to small and medium sized companies. As the small and medium sized companies do not have sufficient volume and sufficient size of capitalization in stock markets, the application of this theory would not serve any of their major objectives. An efficient capital market is based on certain assumptions: first, this theory assumes that the market participants fully understand stocks. And, on the basis of this understanding, they value stocks. Second, a piece of information appears in a random fashion; all pieces of information are independent of each other with regard to timing. Third, fund managers instantly start evaluating the prices of stocks as soon as a new piece of information arrives. In order to make appropriate investment decisions, they carefully monitor the stocks movements. Types of efficient market Weak-form efficient markets In this type, stock prices reflect the historical market information. This type of efficient market is based on the assumption that stock prices reflect currently available historical market information. Consequently, no relationship exists between past and future stock prices. The historical value of information is already incorporated into the current prices. Hence, it would be of no value to study the previous stock prices. Additionally, this type of efficient market hypothesis may be implausible in many situations (Poterba and Summers, 1988; Pesaran and Timmermann, 1995,2000). Semi-strong form efficient market In the semi-strong form, stock prices rapidly adjust to information that is publically available. This stock price adjustment can be upward or downward. It depends upon the nature and type of information available publically.