The Efficient Market Hypothesis:

Criticisms supported by Robert J. Shiller

The Efficient Market Hypothesis: Criticisms supported by Robert J. Shiller

Introduction

In finance, the efficient market hypothesis (short form EMH) is a theory which generalizes that existing stock prices indicate the denomination of the business according to the material available. Further, it suggests that people cannot earn excessive gains by this fully disclosed information. This theory circulates around the criterion of how monetary values differentiate in the stock market.

The key aspect behind the EMH is that profiting from estimating price movements is highly improbable. The main factor contributing to fluctuations in price is the accessibility of innovative data. A financial exchange is considered to be efficient if the values of the securities react instantly, and without cognitions, to the latest data available. This leads to a notion that values will never be too high or too low. Stock price movements adjust prior to any investor having time to gain on discrepancies due to new information (Clarke et al pg. 1-23).

Robert Shiller is a well renowned American economist famous for his criticisms against the EMH. As an academia instructor and financial analyst, Mr. Shiller developed over time several contradictions against the efficient market hypothesis. Supported by Behavioral Finance analysts, Mr. Shiller supports the notion that market prices reflect “animal spirits and passion, not perfect information (Newsweek).” He believes that with the passage of time, more data available certifies the fact that the EMH is ideally 'inefficient.'

Discussion

Rational Expectations

The real dilemma that arises with the EMH being inefficient is the fact that it suggests that all parties interested will have all the information available and create 'rational expectation' forecasts. This suggests that everyone has homogenous considerations about future securities. If this is true, why is their trading in the market? Trading occurs when there are discrepancies in the market. In finance, this is referring to the bulls and bears of the stock market. An individual purchaser forecasts an increase in the securities value, while a merchant forecasts a decline in the securities value. If the people still think that they have all the modern innovation accessible and have perfect and same knowledge, then there exists the discrepancy of interpretation. Each individual's prediction of asset prices is not random as EMH points out but rather is defined according to a certain individual's knowledge (Shostak 1997, p. 27-45).

Buy and Hold Strategy and the Stock Market

The EMH perspective also indicates that the buying and holding approach is the same as any other strategy and due to this, business generated processes in monetary markets don't exist. This is again is a half truth since entrepreneurs are the ones generating new ideas that spread information and in effect, create stock price rises and falls. Information has to come from somewhere, no.

The EMH framework also explains that the stock market and the real world are separate identities. People are aware of the fact that tangible assets cannot have premiums of their own. This explains why investments in stocks are considered as ...