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Assumptions And Forms Of Emh Finance Essay


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The subject of efficient market hypothesis is more deliberated and discussed in available studies, but there is no special focus on the EMH form existing in Gulf area, by these means, this study analyses and evaluates the applicability of this model in some selected countries in Gulf area and how it would affect the decisions regarding the financial issues.

This chapter proposes the outlines of how the subject is going to be investigated and (ii) gives an introductory overview about the topic that is being probed.

At first, the motive of the study is declared and the framework is outlined, so as for the need and purpose of the study; then the research questions are proposed and stated. This section also contains a brief description about the participants which the study comprises. Secondly, the outcomes of the initial review of literature are appointed to form a base for the research questions. Thirdly, the rationalization for the used research approaches is stated, and then the methodology is justified and supported by evidential test that provides validation for the chosen methods.

This section also determines the suggested scheme for chapters 2, 3, 4, and 5. And in the final section, the outcomes of this study will be displayed, and the benefits will be discusses in details for each beneficiary.

Subject And Objectives

The EMH topic fascinates the researcher, and relating the EMH concept to corporate finance through examination of markets can help improve the efficiencies within corporate world as well as increase investors wealth and decision taking. The primary objective of this study is to examine the form of EMH is available in the selected markets which would contribute in guiding these firms in implementing good corporate practices and making these reforms feasible and appropriate, and to identify to what extent EMH constitutes a good approach for financial practices in KSA, UAE, and Kuwait.

While this dissertation aims to study which form of EMH does the selected markets undertake, it doesn't take the burden to prove the accuracy of EMH. After determining which forms of EMH, the benefits to both the investors and corporations interested in the selected markets are huge. It enables the investors to examine if possibility of abnormal earnings exists, while enabling the management to choose wisely its accounting choices, financial choices, and timing decision.

The data for this dissertation is highly accessible. It can be easily retrieved from stock indexes of the selected countries. The dissertation aims to examine stock prices changes covering the last 5 years with data retrieved from Tadawul, ADX, Central Bank, and KSE. This data will then be compared with major economic and company specific events. These events can be retrieved from company's announcement, country's economic reports, newspapers, and specialized financial reports.

Specific research questions include:

What types of information are available in the selected markets? Are they only historical, publicly available, or private/public information?

To what extent the stock prices in the selected markets reflect the available information?

Which forms of EMH do these markets exhibit?

What are the implications for corporate finance associated with these forms which these markets demonstrate (accounting choices, financial choices, and timing decisions)?

Answering research questions provided a general guideline for these groups. In an efficient market, there possibility of abnormal earnings is very minimal, and management can't time their decisions in a manner that affect price stocks greatly. This is the contrast of weak form of EMH, where the possibility of abnormal earnings is high, and management can influence stock prices by timing their decisions.

Preliminary Research

Fama (1970) pioneered the Efficient Market Hypothesis (EMH) by stating that the markets are as efficient as the quantity and quality of information revealed by corporations. He categorized the markets into three forms depending on "whether prices at any point in time "fully reflect" available information" (Fama, 1970, p. 414). The strong form, while only theoretical, suggests that all information is available for investors, thus eliminating the possibility of abnormal earnings. The semi-strong form proposes that prices reflect all publicly available information, while the weak form implies that only historical information is reflected in the price.

Nowadays, no market is isolated from another. Investors, while acknowledging the risks associated with foreign trade, seek cross-border investments to increase their profits, especially if such investments may result in abnormal earnings.

However, international investors must understand the behavior of these markets before diversifying their portfolios into intentional ones (TaÅŸ and TokmakçioÄŸlu, 2010). Similarly, firms operating in such markets can judge the fairness of their securities value based on the market form (Ross, Westerfield, and Jaffe, 2010).

Ross et al (2010) also suggest that market efficiency will impact accounting choices, financial choices, and the timing decisions in the world of corporate finance. In addition, policy makers can benefit greatly from identifying the efficiency of markets, enabling them to better remodel legislations that can attract capital.

This dissertation will focus mainly on three emerging markets: United Arab Emirates (UAE), Kingdom of Saudi Arabia (KSA), and Kuwait. Sabal (2002) provided general characteristics of emerging markets attributes such as uneven wealth distribution, unstable economic and political conditions, and a great portion of uneducated population. While the three countries don't exhibit all the characteristics described by Sabal (2002), they share some of these characteristics, labeling them as having emerging markets. For the purpose of this dissertation, stocks prices of publically listed banks and financial services providers in the three countries will be examined using information retrieved from Tadawul (Saudi Stock Exchange), Abu Dhabi Securities Exchange (ADX), Central Bank of UAE, and Kuwait Exchange (KSE).

Very few researchers have examined EMH in emerging markets (For example Kawakatsu and Morey, 1999, Chaudhuri and Wu, 2003, Chaudhuri and Wu, 2004).Yet the literature on EMH is enormous, containing both supportive and contradictive findings.


The sample covered 30 listed banks and financial service providers; 10 banks in KSA, 7 banks in UAE, and 13 banks in Kuwait.

Collection of data covering a time span of 5 years went through two major phases. The first included changes in stock prices of the selected sample. The second include factors that might affect stock price and are classified in three general categories. The first category will contrast the changes to country specific conditions such as economic changes, political/legal changes, and degree of relation to international markets. The second category contrast the changes in stock prices with company specific conditions such as management financial announcements regarding dividends and profit/loss, and decision making announcements such as retirement or firing of major key players inside the firms (Chairman, CEO). Some other variables are considered such as shocks to reputation and effect of competitors announcements.

Moreover, the impact of other factors has been investigated such as the laws set by the markets, then the country variables that constituted of inflation, interest and exchange rates. In addition, the data gathered included the time span between the factor occurrence and change in price.

The data is then run using SPSS software, which the researcher is very familiar with. Multiple regression analysis is then used to enable the author to examine if a relation exists between the change in stock price and the selected factors, which are the country variables (Inflation, Interest, and exchange rates).

The results of the statistical analysis will then be used to prove or reject the alternative hypothesis (ses). If a relation is established between the factors, it will imply that EMH holds in the selected markets. The time intervals between the factors occurrence and the change in stock price will then indicate how efficient the markets are

The statistical analysis included Descriptive Statistics, which include the numbers, tables, charts, and graphs used to describe, organize, summarize, and present raw data, and then multiple regression analysis is performed to determine the most influential factors in the results.

Outline For Following Chapters

Chapter 2 usually summarizes relevant literature in the introduction to research reports. The review provides readers with a background for understanding and knowledge about a topic and illuminates the significance for the study which helps in determining the similarities and differences.

General information on EMH is included in the literature review but the focus throughout will be on establishing the characteristics of different forms of EMH, as identified by studies that have been conducted locally and internationally. Literature Review provided readers with the needed knowledge and information about EMH, the review is based on reliable resources and academic researches.

Chapter 3 illustrates the quantitative approach findings; it includes the statistical analysis that is performed to identify the results of the survey that consisted of the questionnaires. It represents the study's findings and the statistical analysis results. This analysis provided the researcher with the data that is interpreted and prepared to evaluate the suggested hypotheses.

Chapter 5 is the discussions of the results; it reviews the theoretical hypotheses, and evaluates the compatibility of these hypotheses to the selected countries context. The findings of the analysis are used to evaluate the certainty or the rejection of the suggested hypotheses. Conclusions are made based on analysis which helped in formulating the general concept about the EMH model and how effective it is in the selected markets. The analysis of the hypotheses helped in identifying the research questions that are the researcher main concern.


The proposed research will have benefits for these principle beneficiaries, namely the author or researcher, the academic community, Professional Associations, Trainers and Developers, Managers and Organizations, and Policy Makers and Regulators:

The author or researcher: As an educator, the study will help in developing better comprehensive ideas about efficient market hypothesis, and to what extent it is needed, and how EMH is affected by different variables and factors.

The Academic Community: The research will add to the poor studies and researches base about EMH in KSA, UAE, and Kuwait markets and will also add to the available literature. The research could also work as a reference to future researches about this subject or any of its elements.

Professional Associations, Trainers and Developers: There is a scarcity of research concerning the effects of many factors on EMH and what type of EMH exists in the selected countries. Therefore, this study will be valuable to educationists, course administrators, and other researchers who work on related fields.

Managers and Organizations: Create awareness about the important of identifying the form of EMH that their markets endorse, eventually, the results of this study might make corporate decision-makers become more aware of the use of EMH as a financial tool.

Policy Makers and Regulators: The research will guide them about the context concerning the prospects that may encounter in case EMH tool is applied in the selected countries.


This chapter aims to give a general review of the literature on the effect of EMH on the financial markets more specifically on banks. This section includes a theoretical background of EMH, it explores it by including its definitions and essential elements, and it also provides some reviews of literature conducted on the investigated subject.


A market is said to be efficient with respect to an information set if the price 'fully reflects' that information set, i.e. if the price would be unaffected by revealing the information set to all market participants. The efficient market hypothesis (EMH) asserts that financial markets are efficient. On the one hand, the definitional 'fully' is an exacting requirement, suggesting that no real market could ever be efficient, implying that the EMH is almost certainly false (Fama, 1970).

On the other hand, economics is a social science, and a hypothesis that is asymptotically true puts the EMH in contention for one of the strongest hypotheses in the whole of the social sciences. Besides, science concerns seeking the best hypothesis, and until a flawed hypothesis is replaced by a better hypothesis, criticism is of limited value.

There are always incentives and motives to develop a market that enables buyers and sellers to discover information and to elaborate a social arrangement to allow them to carry out a voluntary exchange more efficiently. The securities markets tend to be the largest and best organized markets in the world. The concept 'efficient market' was at first used to the stock market, but the term was soon generalized to other asset markets (Tabak, 2003).

An efficient portfolio is one with the highest expected return for a given level of risk. An efficient market is one in which information is rapidly disseminated and reflected in prices (Mishkin, 1997).

The EMH has been the central proposition of finance since the early 1970s and is one of the most controversial and well-studied propositions in all the social sciences (Smith and Ryoo, 2003). Efficient market concept has been applied in an extensive way to theoretical models and empirical studies of financial securities prices, creating significant controversy, additionally to fundamental insights into the price-discovery process (Lo, 2007).

As quoted by Andrew Lo (2007): "The most enduring critique comes from psychologists and behavioral economists who argue that the EMH is based on counterfactual assumptions regarding human behavior, that is, rationality. Recent advances in evolutionary psychology and the cognitive neurosciences may be able to reconcile the EMH with behavioral anomalies." A decade after the EMH idea has been generated, many people extended their framework to allow for risk-averse investors, resulting in a 'neoclassical' version of the EMH where price changes, properly weighted by aggregate marginal utilities, must be unforecastable (LeRoy, 1973; M. Rubinstein, 1976; and Lucas, 1978).

Given all of the theoretical and empirical evidence for and against the EMH, there is still no consensus among economists. Despite progress in the statistical analysis, databases, and theoretical models surrounding the EMH, the main result of all of these studies is to harden the resolve of the proponents of each side of the debate (Lo, 2007).


Information in the Efficient Market Hypothesis is defined as anything that may affect prices that is unknowable in the present and appears at random in the future. EMH indicates that it is not possible to always outperform the market by using any information that the market already knows, except through luck (Fama and French, 1992).

EMH affirms that financial markets are informationally efficient, and that the prices on stocks, bonds, or property already reflect all known information, therefore are unbiased in the sense that they reproduce the common beliefs of all investors about future forecasts (Fama, 1970). The term 'efficient market' was first introduced into the literature by Fama in 1965, then it was followed by many subsequent definitions, the following quote illustrate one of these definitions:

Fama (Sep.-Oct. 1965) in Random walks in stock market prices: 'An "efficient" market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants.'


The term "Efficient market hypothesis" (EMH) was developed by Professor Eugene Fama at the University of Chicago Graduate School of Business as an academic concept of study through his published Ph.D. thesis in the early 1960s. Chronological reviews and researches related to EMH started since the 16th century, table 2.1 resumes the evolving of EMH in the literature from year 1565 until year 1997, showing different outcomes and findings and conclusions made by these researchers throughout different period of time, which formulated the EMH concept. And after reviewing this table, we can notice that approximately half of the papers reviewed support market efficiency, with most of the attacks on the EMH coming in the 1980s and 1990s.

Since the first introduction of "efficient market" term, there have been many empirical researches that contributed in the evolution and formulation of the efficient market hypothesis, as it was tested in different situations and circumstances using different variables, and implying different outcomes, which created some controversial debates and arguments which either supported or rejected the validity of the hypotheses. The following, will show how EMH evolved through literature (Sewell, 2011):

Fama defined an "efficient" market for the first time in 1965, in his empirical analysis of stock market prices that concluded that they follow a random walk. In the same year, Samuelson provided the first formal economic argument for "efficient markets". In the following two years, Harry Roberts coined the term "efficient markets hypothesis" and made the distinction between weak and strong form tests, which became the classic taxonomy in Fama (1970). Fama, Fisher, Jensen and Roll undertook the first ever event study in 1969, and their results lend considerable support to the conclusion that the stock market is efficient.

Eugene F. Fama's definitive paper on the efficient markets hypothesis, in 1970, defined an efficient market as a market in which prices always "fully reflect" available information is called "efficient". Two years later, Scholes studied the price effects of secondary offerings and found that the market is efficient, except for some indication of post-event price drift. In 1978, Jensen announced that there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis. While Ball wrote, in the same year, a survey paper which revealed consistent excess returns after public announcements of firms' earnings.

LeRoy and Porter's research, in 1980, showed excess volatility and market efficiency is rejected. While Stiglitz showed that even with apparently competitive and "efficient" markets, resource allocations may not be Pareto efficient. Werner F. M. DeBondt and Richard Thaler discovered, in 1985, that stock prices overreact; evidencing substantial weak form market inefficiencies: This paper marked the start of behavioral finance. The following year, Lawrence H. Summers argued that many statistical tests of market efficiency have very low power in discriminating against plausible forms of inefficiency. Shiller published "Market Volatility" in 1989, which was a book about the sources of volatility which challenges the EMH.

In 1990, Laffont and Maskin showed that the efficient market hypothesis may well fail if there is imperfect competition. In the same year, Lehmann found reversals in weekly security returns and rejects the efficient markets hypothesis. After two years, Chopra, Lakonishok and Ritter found that stocks overreact. In the same year, Malkiel's essay "Efficient Market Hypothesis" is in the New Palgrave Dictionary of Money and Finance.

In 1994, Roll observed that in practice it is hard to profit from even the strongest market inefficiencies. While, Metcalf and Malkiel found that portfolios of stocks chosen by experts do not consistently beat the market. Then in 1995, Haugen published the book "The New Finance: The Case Against Efficient Markets", which emphasized that short-run overreaction may lead to long-term reversals. A year later, Chan, Jegadeesh and Lakonishok look at momentum strategies and their results suggested a market that responds only gradually to new information. And in 1997, Andrew Lo edited two volumes that brought together the most influential articles on the EMH.

Assumptions And Forms of EMH

Beyond the normal utility maximizing agents, the efficient market hypothesis requires that agents have rational expectations whenever new significant information appears; the agents must update their expectations properly (Sewell, 2011).

EMH points out that some investors when faced with new information may over-react and some may under-react. EMH requires that investors' reactions should be random and follow a normal distribution pattern so that the net effect on market prices cannot be reliably broken to make an abnormal profit, especially when considering transaction costs, including commissions and spreads. Thus, anyone can be wrong about the market but the market as a whole is always right (Blakey, 2006).

There are three common forms in which the efficient market hypothesis is commonly stated, and they are: weak form efficiency, semi-strong-form efficiency, and strong-form efficiency, each of which has different implications for how markets work.

Weak-Form Efficiency

Weak-form EMH is a shot aimed directly at technical analysis. If past stock prices don't help to predict future prices, there's no point in looking at them. Most academic studies tend to show that weak-form EMH holds up pretty well (Pistor, 2003).

As stated, in the weak-form EMH, the price reflects all information contained in market trading data (past prices, volume, dividends, interest rates, etc.). Therefore, an investor cannot use past prices to identify mispriced securities (Pistor, 2003).

The technical analysis for Weak-form EMH refers to the practice of using past patterns in stock prices and trades to identify future patterns in prices.

A form of the theory that suggests you can't beat the market by knowing past prices. Distinctive features are (Hagin, 1979):

No excess returns can be earned by using investment strategies based on historical share prices or other financial data.

Weak-form efficiency implies that technical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysis may still provide excess returns.

In a weak-form efficient market current share prices are the best, unbiased, estimate of the value of the security. Theoretical in nature, weak form efficiency advocates assert that fundamental analysis can be used to identify stocks that are undervalued and overvalued. Therefore, keen investors looking for profitable companies can earn profits by researching financial statements.

Semi-Strong Form Efficiency

Perhaps the most controversial form of the theory, it suggests you can't consistently beat the market using publicly available information. That is, you can't win knowing what everyone else knows - annual reports etc. Most distinctive features are:

Share prices adjust within an arbitrarily small but finite amount of time and in an unbiased fashion to publicly available new information, so that no excess returns can be earned by trading on that information.

Semi-strong form efficiency implies that fundamental analysis techniques will not be able to reliably produce excess returns.

To test for semi-strong form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner.

Semi-strong EMH is a shot aimed at fundamental analysis. If all published information is already reflected in a stock's price, then there's nothing to be gained from looking at financial statements or from paying somebody (i.e., a fund manager) to do that for you (Pistor, 2003).

Semi-strong EMH has also held up reasonably well. For example, the number of active fund managers who outperform the market has historically been no more than can be easily attributed to pure randomness. The Fundamental analysis refers to the practice of using financial statements, announcements, and other publicly available information about firms to pick stocks (Pistor, 2003).

The trick, of course, is that it's nearly impossible to identify such an investor in time to profit from it. You must either (Hagin, 1979):

Invest with a fund manager after only a few years of outperformance (at which point his/her performance could easily be due to luck), or

Wait until the manager has provided enough data so that you can be sure that his performance is due to skill (at which point his fund will be sufficiently large that he'll have trouble outperforming in the future).

Let's consider the following example:

Market reaction to public announcement:

Stock XYZ Mining closed yesterday at 100.

Morning paper reports: XYZ Mining has larger than expected reserves (extra value = $10 per share).

Suppose this estimate is unanimously and immediately deemed valid and accurate.

Stock jumps to 110 immediately at the open.(More likely 109.9 bid, 110.1 offered.)

No trading is needed.

News report "XYZ climbed to 110 today on announcement of a new gold mine."

Suppose XYZ Mining stock only jumps to 104:

Report might be suspicious ("XYZ known to exaggerate").

But if we deem the information reliable:

- A price of 104 for XYZ does not accurately reflect all the available information.

- We can make trading profits by buying XYZ at 104 and holding until:

a. The market realizes we're right, or

b. XYZ pays out (in dividends or distributions) the value of the reserves.

- Semi-strong efficiency is violated in the senses that 104 does not fully reflect the new information. We can make trading profits.

Strong-form Efficiency

The strong form of EMH says that everything that is knowable, even unpublished information has already been reflected in present prices. The implication here would be that even if you have some inside information and could legally trade based upon it, you would gain nothing by doing so (Pistor, 2003).

The form of the theory that states no information of any kind can be used to beat the market. Evidence shows this form does not hold. Features of this form are (Hagin, 1979):

Share prices reflect all information and no one can earn excess returns.

If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. Studies on the U.S. stock market have shown that people do trade on inside information.

To test for strong form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. Even if some money managers are consistently observed to beat the market, no refutation even of strong-form efficiency follows: with tens of thousands of fund managers worldwide, even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers.

In Strong-Form EMH, All Private Information is reflected; private Information is information that you hold that is not reflected in the market price. There are two types of Private Information (Pistor, 2003):

a. "Inside information" is an info that is known to company management but not yet made public.

- Knowledge of an impending takeover bid.

- Knowledge that earnings are going to be lower than the street expects.

b. A private assessment based on public information.

- An analyst's report based on public accounting statements.

Let's assume this example:

Private information can be impounded into the security price via reported trades.

Stock XYZ Mining closed yesterday at 100.

Opening quotes today are 99.9 bid; 100.1 offered.

We overhear two geologists talking on the subway:

"XYZ Mining has larger than expected reserves (extra value = $10 per share)."

We begin to buy at the ask (100.1):

- Quotes revised to 100 bid, 100.2 offered.

- We buy more at 100.2.

- Quotes revised to 100.1 bid, 100.3 offered.

We will stop buying only when the price reaches 110.

Market price will be 110, reflecting the private information.

Market reaction is not driven directly by the private info, but instead by the related buying.

Trader profits at the expense of other market participants, those who have exposed offers, either dealers or limit-order traders.

The Qualifications that should be looked for are:

Timing of trades unclear (all at once? spread out over time?)

If more than one trader gets the info, most of the profits accrue to the one who trades first.

Trader might be capital-constrained (might not have enough cash to buy all the stock that is offered below 110).

Arguments Concerning The Validity of The Hypothesis

Some Common Misconceptions about the EMH are (Beechey, Gruen and Vickrey, 2000):

Market efficiency does not mean it doesn't make a difference how you invest, since the risk/return trade-off still applies, but rather that you can't expect to consistently "beat the market" on a risk-adjusted basis using costless trading strategies.

Stock price fluctuations are evidence that the market is efficient since new information is constantly arriving - prices that don't change are evidence of inefficiency. The EMH doesn't say prices are random, but that price changes in an efficient market are random and independent. That is, they can't be predicted before they happen.

Some technical analysts argue investors overreact to good and bad news. Advice is to buy on bad news and sell on good news. This implies that returns should exhibit negative serial dependence because price reversals are more likely than continuances of price changes (DeBondt, Werner and Richard, 1985).

Some observers dispute the notion that markets behave consistently with the efficient market hypothesis, especially in its stronger forms. Some economists, mathematicians and market practitioners cannot believe that man-made markets are strong-form efficient when there are reasons for inefficiency including the slow diffusion of information, the relatively great power of some market participants (e.g. financial institutions), and the existence of apparently sophisticated professional investors. The way that markets react to surprising news is perhaps the most visible flaw in the efficient market hypothesis. For example, news events such as surprise interest rate changes from central banks are not instantaneously taken account of in stock prices, but rather cause sustained movement of prices over periods from hours to months (Hagin.1979).

Only a privileged few may have prior knowledge of laws about to be enacted, new pricing controls set by pseudo-government agencies such as the Federal Reserve banks, and judicial decisions that affect a wide range of economic parties. The public must treat these as random variables, but actors on such inside information can correct the market, but usually in discrete manner to avoid detection (Malkiel, 2003).

Another observed discrepancy between the theory and real markets is that at market extremes what fundamentalists might consider irrational behaviour is the norm: in the late stages of a bull market, the market is driven by buyers who take little notice of underlying value. Towards the end of a crash, markets go into free fall as participants extricate themselves from positions regardless of the unusually good value that their positions represent. This is indicated by the large differences in the valuation of stocks compared to fundamentals (such as forward price to earnings ratios) in bull markets compared to bear markets (Malkiel, 2003).

A theorist might say that rational (and hence, presumably, powerful) participants should always immediately take advantage of the artificially high or artificially low prices caused by the irrational participants by taking opposing positions, but this is observably not, in general, enough to prevent bubbles and crashes developing. It may be inferred that many rational participants are aware of the irrationality of the market at extremes and are willing to allow irrational participants to drive the market as far as they will, and only take advantage of the prices when they have more than merely fundamental reasons that the market will return towards fair value (Dupernex, 2007).

Behavioral finance explains that when entering positions market participants are not driven primarily by whether prices are cheap or expensive, but by whether they expect them to rise or fall. To ignore this can be hazardous: Alan Greenspan warned of " irrational exuberance" in the markets in 1996, but some traders who sold short new economy stocks that seemed to be greatly overpriced around this time had to accept serious losses as prices reached even more extraordinary levels (Schiller, 2003). As John Maynard Keynes succinctly commented, "Markets can remain irrational longer than you can remain solvent."

The efficient market hypothesis was introduced in the late 1960s. Prior to that, the prevailing view was that markets were inefficient. Inefficiency was commonly believed to exist e.g. in the United States and United Kingdom stock markets (Dupernex, 2007). However, earlier work by Kendall (1953) suggested that changes in UK stock market prices were random. Later work by Brealey and Dryden, and also by Cunningham found that there were no significant dependences in price changes suggesting that the UK stock market was weak-form efficient.

Further to this evidence that the UK stock market is weak form efficient, other studies of capital markets have pointed toward them being semi strong-form efficient. Studies by Firth (1976, 1979 and 1980) in the United Kingdom have compared the share prices existing after a takeover announcement with the bid offer. Firth found that the share prices were fully and instantaneously adjusted to their correct levels, thus concluding that the UK stock market was semi strong-form efficient. The market's ability to efficiently respond to a short term and widely publicized event such as a takeover announcement cannot necessarily be taken as indicative of a market efficient at pricing regarding more long term and amorphous factors however.

Other empirical evidence in support of the EMH comes from studies showing that the return of market averages exceeds the return of actively managed mutual funds. Thus, to the extent that markets are inefficient, the benefits realized by seizing upon the inefficiencies are outweighed by the internal fund costs involved in finding them, acting upon them, advertising etc. These findings gave inspiration to the formation of passively managed index funds (Blakey, 2006).

It may be that professional and other market participants who have discovered reliable trading rules or stratagems see no reason to divulge them to academic researchers. It might be that there is an information gap between the academics who study the markets and the professionals who work in them. Some observers point to seemingly inefficient features of the markets that can be exploited e.g seasonal tendencies and divergent returns to assets with various characteristics. E.g. factor analysis and studies of returns to different types of investment strategies suggest that some types of stocks may outperform the market long-term (e.g in the UK, the USA and Japan) (Chen, Shu-Heng and Chia-Hsuan, 2002).

Skeptics of EMH argue that there is a small number of investors, who have outperformed the market over long periods of time, in a way which is difficult to attribute luck, including Peter Lynch, Warren Buffett, George Soros, and Bill Miller. These investors' strategies are to a large extent based on identifying markets where prices do not accurately reflect the available information, in direct contradiction to the efficient market hypothesis which explicitly implies that no such opportunities exist (Malkiel, 1996).

Among the skeptics, who argued that the EMH is not correct, is Warren Buffett, saying "I'd be a bum on the street with a tin cup if the markets were always efficient" and on another saying ". The professors who taught Efficient Market Theory said that someone throwing darts at the stock tables could select stock portfolio having prospects just as good as one selected by the brightest, most hard-working securities analyst (Krause, 2010). Adherents to a stronger form of the EMH argue that the hypothesis does not preclude the existence of unusually successful investors or funds occurring through chance.

Warren Buffett wrote in 1962: "I present this data to indicate the Dow as an investment competitor is no pushover, and the great bulk of investment funds in the country are going to have difficulty in bettering, or even matching, its performance. Our portfolio is very different from that of the Dow. Our method of operation is substantially different from that of mutual funds."

EMH is commonly rejected by the general public due to a misconception concerning its meaning. Many believe that EMH says that a security's price is a correct representation of the value of that business, as calculated by what the business's future returns will actually be. Therefore, they believe that EMH says a stock's price correctly predicts the underlying company's future results since stock prices do not reflect company future results in many cases, many people reject EMH as clearly wrong (Fama, 1998).

However, EMH says that a stock's price represents an aggregation of the probabilities of all future outcomes for the company, based on the best information available at the time, whether that information turns out to have been right or accurate, is not something necessary by EMH. It does not require a stock's price to reflect a company's future performance, just the best possible estimate of that performance that can be made with publicly available information (Fama, 1998).

Behavioral finance, an alternative theory

Adversaries of the EMH theory mention examples of market movements that seem incomprehensible in terms of conventional theories of stock price determination, such as example is the "October 1987" stock market crash, where most stock exchanges crashed at the same time. It is hard, almost impossible, to explain the level of those market falls by reference to any news event at the time; the explanation may lie either in the exchanges mechanics, such as no safety nets to discontinue trading initiated by program sellers, or the characteristics of human nature (Schiller, 2003).

Behavioral psychology approaches to stock market trading are among some of the alternatives to EMH. A growing field of research called behavioral finance studies cognitive or emotional biases and anomalies in market prices and returns which may be hard to explain via EMH alone. Nobel Laureate co-founder of the program, Daniel Kahneman, stated that: "investors just not going to beat the market. It's just not going to happen", in a way announcing his skepticism of resultant inefficiencies (Schiller, 2003).

Behavioral finance program can also be used to agilely support the EMH, or it can explain the skepticism drawn by EMH, in that it helps to explain the human tendency to find and exploit patterns in data even where none exist (Schiller, 2003).

Capital Market Efficiency

Efficient Capital Market is a market in which current market prices fully reflect available information. one in which costless trading rules do not consistently beat the market. Competition among investors and traders makes a market efficient (Balaban, Candemir and Kunter, 1996).

Price Behavior in an Efficient Market: It is a stock price reaction in efficient and inefficient markets.

The Efficient Market Hypothesis: EMH asserts that modern U.S. stock markets are efficient. The important implication of the EMH is securities as they are expected to return just exactly their risk-adjusted rate (Berument and Kiymaz, 2001).

The capital market history relation with the EMH (Berument and Kiymaz, 2001):

Prices respond very rapidly to new information.

Future prices changes are difficult to predict.

Mispriced stocks, those whose future price level can be predicted accuratel, are difficult to identify and exploit.

Announcement Effect

Announcement effect is defined as the impact on markets from the news that a change will occur at some future date. It can be used as a general term for the reaction to any development that affects trading. It is most often employed to describe investor's reactions to changes in monetary policy, such as cut in a key interest rate level. And it is also known as a "signal effect" (Bomfan, 2000).

A good example of announcement effect would be when stock traders excitedly wait for the changes announcement in Federal Reserve policy, and stock volumes are notably higher on Fed days; and it is also noticed that trading on the day prior announcements of Fed policy is somewhat calm (Bomfan, 2000).

Whereas bank announcement is an announcement made by the bank, usually after their first meeting of the month and it is dedicated to monetary policy. Bank announcements are considered to be significantly important since because most banks do not publish the minutes of their meetings, therefore, the outcome of the announcement will affect the stock and bond markets; an outcome could be a change in interest rates, where higher or lower interest rates are bearish or bullish for stock markets and bullish or bearish for bond markets (Bomfan, 2000).

Overview About Financial Markets In Kuwait, KSA, & UAE


The Kuwait Financial Market is an indicator of the flourishing economy of Kuwait. All major players of the treasury, financial and capital markets industries are active members of this association.

Kuwait financial market also has considerable influence in the Middle East and Gulf region. The money market, capital market and other derivative sectors are very well developed in Kuwait. The official and industry authorities are very well informed about market conditions and this enhances the growth of the financial sector in Kuwait (CBK, 2012).

The Kuwait Stock Exchange or the KSE was established in 1977. Share trading in the country had started as early as 1952. Securities trading are done with ease, fairness and efficiency in this place.

The Foreign Investment Law enacted on the 10th of September 2000 has made foreign investments in the Kuwait Stock Exchange possible. It is one of the largest stock exchanges in the Gulf region (CBK, 2012).

The Central Bank of Kuwait, which was established in 1969, plays a crucial role in facilitating the monetary transactions of Kuwait financial market. This bank ensures a stable financial environment in the country. It acts as the chief financial adviser of the government. The Central Bank of Kuwait is also the chief regulatory authority of the banks and other financial institutions of the country. That way, it can keep a watch on the Kuwait financial market (CBK, 2012).

The National Bank of Kuwait has said the Gulf country's GDP growth is likely to reach a healthy-looking 5.4% in 2012, but growth in the non-oil sector, at 4%, will remain below the regional average. The country's consumer price inflation is expected to average 3-4% this year and next, little changed from recent levels, NBK said in the report. Key factors holding the economy back are the slow pace of execution of the government's four-year development program (2010/11-2013/14), and lingering effects from the financial crisis, which have undermined business confidence, said the report (CBK, 2012).

Kuwait's long-term foreign and local currency issuer default ratings at "AA" have been reaffirmed by Fitch Ratings with a 'Stable' outlook, supported by huge foreign assets and high oil prices, AFP has reported. However, the ratings agency warned against heavy reliance on oil income and continued political disputes between MPs and the government that hinder reforms. The "ratings are primarily supported by its strong sovereign net foreign assets, estimated by Fitch at $323 billion in 2011," the international ratings agency said, citing a budget surplus over the past 13 fiscal years (CBK, 2012).

United Arab Emirates (UAE)

The Dubai Financial Market is one of three stock exchanges in the UAE located in Dubai and that was founded on March 26, 2000. There are about 61 companies listed (as of May 2012) on DFM, most of them are UAE-based companies and a few dual listings for companies based in other MENA region countries. Foreign companies are from the following countries: Kuwait, Bahrain, Oman, and Sudan. Many companies allow foreigners to own their shares.

During 2004 and 2005, there were significant increases in the volume of shares traded and the share prices of many companies. However, towards the end of 2005 and through the first few months of 2006 the bubble burst and share values dropped by around 60% on DFM, along with similar decreases in most other Persian Gulf stock markets (Squalli, 2005).

Abu Dhabi Securities Exchange (ADX) also lists mostly UAE companies and NASDAQ Dubai was set up to trade international stocks (Squalli, 2005). DFM and ADX are both governed and regulated by the Securities and Commodities Authority (SCA). On the other hand, NASDAQ Dubai is governed to international standards by an independent regulator called the Dubai Financial Services Authority (DFSA), which is equivalent to the Securities and Exchange Commission in the U.S. Unlike DFM and ADX, NASDAQ Dubai, located in Dubai International Financial Centre (DIFC), is an electronic exchange with no trading floor (Squalli, 2005).

DFM was a fully owned by Dubai government till November 2006 when it turned into a public joint stock company through an IPO, which led to sell 20% of its shares to public and 80% were subscribed by Borse Dubai, which is owned by Dubai government. As a matter of fact, DFM's IPO has been oversubscribed by 118 times (Squalli, 2005).

Like the revenue, DFM net profit dropped sharply from the period ended 2007 till 2011. In 2007, DFM profits reached 1,439.6 million including none operational profits coming from IPO of AED 468 million. In 2008 profits are only 605 AED million. The next year, in 2009, the profit dropped even further and reached 346.62. in 2010, another drop took place and profits reached AED 79 million. Unfortunately, in 2011, DFM recorded a loss of AED 6.45 million. From the trend, we can imply that the situation is not improving, but is deteriorating year after year. DFM BOD members, executives, and managers are working hard to get out DFM from this unforeseen dilemma (Squalli, 2005).

Saudi Arabia (KSA)

Like the U.A.E., Saudi Arabia is distinguished by a high degree of bank stability, efficiency, and profitability. But the sector is small relative to Saudi Arabia's GDP and population of 25 million. Commercial access to capital is quite good and the tax system does not distort. But corporate governance is murky and financial disclosure poor-and Saudi Arabia has a long way to go to develop its human capital (Ingves and Khan, 2004).

Despite the overall robustness of the banking sector and its supporting infrastructure, domestic intermediation remains relatively limited, with bank claims on the private sector amounting to only 29 percent of GDP (or 51 percent of nonoil GDP). Far-reaching reforms aimed at developing a more diversified intermediation framework to meet the financing needs of the population are either being implemented or being considered, and should be supported by broader institutional efforts (Ingves and Khan, 2004).

The equity market is buoyant, with significant turnover and the largest market capitalization among Arab stock exchanges; however, there is limited provision of investment information. Corporate bond markets are fledging and the statutory caps on issuance could be removed with an amendment to the Companies Law of 1965. The proposed introduction of a primary dealership system for Saudi government securities presents an opportunity to strengthen the functioning of the debt market to provide greater depth to systemic liquidity arrangements, broaden the base for deficit financing arrangements and, importantly, provide more robust yield curves that could catalyze longer-term markets (Ingves and Khan, 2004).

Saudi Arabia has a diverse financial system compared with other countries in the region. By international standards, however, its banking sector is modest in size, with M3 equivalent to 52 percent of GDP at end-2003. Asset intermediation is limited, with commercial bank claims on the domestic private sector amounting to 29 percent of GDP (51 percent of nonoil GDP). Crossborder activity, in contrast, is substantial, with commercial bank gross and net foreign assets amounting to 10 percent and 5 percent of GDP, respectively (Ingves and Khan, 2004).

Bank portfolios in Saudi Arabia are shaped by three factors. First, assets are substantially funded by low-cost demand deposits, which account for up to 40 percent of total deposits, which with lending rates determined internationally largely explains consistently robust profitability. Second, the dependence of the economy on oil makes it difficult for banks to diversify risks domestically, particularly credit risk, necessitating high levels of capital and provisioning. Third, conservatism is further ensured by prudential arrangements that prescribe lending limits, including to connected parties, liquid asset ratios (Ingves and Khan, 2004).

Overview About The Research Methodology

This dissertation undertakes a quantitative angle to reach a valid, credible, accurate and neutral outcome based on the guidelines suggested by Thomas and Magilvy (2011). Taking into account ethical considerations, this study will build on the work of Lee, Lee and Lee (2010) in adopting a structural break model. While this study acknowledges other available methods such as the univariate unit root with/without breaks and panel unit root with/without breaks methods, the author believes that the model developed by Maheuand Song (2012) will result in more accurate results.

The dissertation will also compare the results using the above mentioned model with other panel unit root and stationary tests without structural breaks models, namely LLC (Levin, Lin and James Chu, 2002), IPS (Im, Pesaran, & Shin, 2003), Fisher-ADF and Fisher-PP (Maddala and Wu, 1999).

As mentioned, the sample covered listed banks in Kuwait, KSA, and UAE. Collection of data covering a time span of 5 years will go through two major phases. The first will include changes in stock prices of the selected sample.

The second include factors that might affect stock price and are classified in three general categories. The first category will contrast the changes to country specific conditions such as economic changes, political/legal changes, and degree of relation to international markets.

The second category contrast the changes in stock prices with company specific conditions such as management financial announcements regarding dividends and profit/loss, and decision making announcements such as retirement or firing of major key players inside the firms (Chairman, CEO).

Some other variables will be considered such as shocks to reputation and effect of competitors' announcements. In addition, the data gathered will include the time span between the factor occurrence and change in price. Hypothesis will mainly focus on using a null hypothesis and alternative hypothesis (hypotheses).

The data will then be run using SPSS software. The first step will include verifying the validity of data by running validity test and commonalities among variables. The second step will examine if the data is reliable by performing reliability analysis. A frequency test will enable the author to examine what factors have similar impact on the selected companies' stock price. Chi-square will be conducted to assess test of goodness of fits and tests of independence. Multiple regression analysis will then be used to construct a formula that predicts the change of stock price given the value of the factors considered, and will enable the author to examine if a relation exists between the change in stock price and the selected factors.

The results of the statistical analysis will then be used to prove or reject the alternative hypothesis(ses). If a relation is established between the factors, it will imply that EMH holds in the selected markets. The time intervals between the factors occurrence and the change in stock price will then indicate how efficient the markets are.


Regardless of whether or not to believe that markets are efficient, the efficient market hypothesis is a proper indicator and the place to start with when thinking about asset price formation. It serves as a framework for trying to understand the movements in stock prices and probably, it is the single most important paradigm in finance, it helps in understanding and formulating a basis for various investment strategies and also explain why prices move the way they do.

The familiar and common explanations for market efficiency are that market efficiency is the quality or degree of being efficient, effective operation as measured by a comparison of "production/energy" with "cost/output", in summary, it is an informational efficiency, i.e., the measure of how quickly and accurately the market reacts to new information.

The fundamental value of an asset is implied by the cumulative impact of information we receive as news. Successive news items must be random because if an item of news were not random, or if it were dependent on earlier news, then it wouldn't be news at all. If the fast price reflects all information, in other word the market is efficient, then the price will fluctuate randomly.

As been shown through reviewing literature, evidence supports weak and semi-strong forms of market efficiency but not strong form. The implication that could be faced is to make excess profits there is a need for information that no one else has or the Ability to process available information much better.

EMH is a concept and a model whereby a model can be wrong in some respects but right and useful in many other ways. We notice some skeptics in this model such as Buffet. Moreover, the financial crisis that started in 2007 further undermined EMH as a safe assumption. But a widely accepted and less wrong alternative to EMH has not emerged (Krause, 2010).

But in the world of the efficient market, Warren Buffett would be a failure, because no matter how cleverly he examined financial statements, he never would be able to find an undervalued stock (Forbes magazine).

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