The notion of efficient market can be traced back to Bachelier(1900) in his dissertation. According to his research, the expected return for each investor can be seen as an independent event, and the samples are close to normal distribution. That means, therefore, the expected return for the security is zero and the stock prices are unpredictable.
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As he stated, “past, present and even discounted future events are reflected in market price, but often show no apparent relation to price changes” The newly rising concept challenged the former economic theory which focus on estimating the future security prices, but unfortunately, his contribution was not valued until the later scholars had came up empirical evidence and developed to “random walk theory”, which is seen as the origin of market efficiency. With further understanding of random walk model, in which assuming the stock price is not predictable, Samuelson(1965) then carried out resembling researches in stock markets. He found that if there was a technical indicator implying that the stock price would rise, it would have already been raised by the coming investors. (cited in )Thus, the increased price led the indicator disappear and the stock price reset to the random position. “Arguments like this are used to deduce that competitive prices must display price changesÃ¢â‚¬Â¦that perform a random walk with no predictable bias. ” Basing on previous approaches, Fama(1969) concluded those literatures reviews and produced market efficiency hypothesis with relevant evidence. In his paper, he defined market efficiency hypothesis, in the meaning that the stock prices have fully reflected the related information in capital market. Therefore, it is unreasonable to earn abnormal profits by using the public news. In other words, those excess returns gained by speculators are merely occasional chances and may disappear through frequent operation.(Fama 1991)
Although it is important to establish a theory upon controlled assumptions, the background of those has also to be suspected if it is alive in reality. As Fama(1969) stated, the market hypothesis have to build up on four assumptions, which will be described as below. Nevertheless, a volume of researchers have proposed opposition to challenge the theory. The major criticism will then be presented. To begin with the first assumption, the hypothesis assumes there is no transaction cost, taxation, and other expense in capital market. Ruling out the cost, the stock prices are close to random walk theory and there are no opportunities to make profits because of the unpredictability. However, it is impossible to exist such pure economic surroundings as Fama(1969) state. Thus, The hypothesis have face the challenges of whether it is applicable in financial markets. The continuous point of control variable has been stated that the relevant information is spread to every investor at the same time for free,
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