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Does the existence of abnormal returns made by the likes of Warren Buffett’s indicate market inefficiency or is this a black swan? 

What is Efficient Market Hypothesis (EMH)?

Warren Buffet does not believe in efficient market hypothesis. He is one of the greatest investors in current scenario. Warren Buffet believes that the share price of a particular company could be controlled by the inventors by selling bulk shares or buying bulk shares at any time. Due to the information and insider knowledge about the security market, Warren Buffet managed to outperform in the market and the companies of Warren Buffet has managed to maintain a good average market rate. The report explains about the EMH and the related forms of EMH in a security market.

Efficient market hypothesis is a financial theory which explains that it is not possible for anyone to beat the stock market and stock price of an organization reflects about entire position and performance of an organization. EMH theory explains that a stock is always traded in its fair value and it makes it sure that no stock is purchased or sold in over or under value (Watson and Head, 2016). Though, the theory of EMH is highly controversial as people believe that technical and fundamental analysis is pointless while evaluating a stock’s price.

Though, it is believed by EMH theory that market is efficient. However, the EMH could be categorized into 3 levels, which are as follows:

  1. Weak form EMH:

Weak form of EMH explains that it is assumed that the market’s rate of return is independent. These values changes independently and the market index does not make an impact on the stock price of the company (Degutis and Novickyte, 2014).

  1. Semi strong EMH:

Semi strong form of EMH explains that it is assumed that the market’s rate of return is semi independent. These values changes with the help of market index as well as with the internal changes in the organization, stock price of the company is linked with both the internal changes as well as market index.

  1. Strong EMH:

Further, strong form of EMH explains that it is assumed that the market’s rate of return is dependent on market index. These values changes only with the help of market index. Stock price of the company is linked with the market index (Narayan, Narayan, Popp and Ali Ahmed, 2015). With the change in market index, stock price would automatically change.

It explains that there are three forms of EMH. The form of EMH could be identified by any analyst through various financial techniques such as evaluating the market index. Exchange specialist, regression, event test, trading test etc.

Warren Buffet's perspective on EMH

Hamid et al, (2017) has explained that efficient market hypothesis (EMH) is a theory of finance which explains that it is not possible for anyone to beat the stock market.  Stock price of an organization reflects about inside changes of the organization. Further, it has been added by Marwala and Evan, (2018) that EMH theory explains that a stock is always traded in its fair value and it makes it sure that no stock is purchased or sold in over or under value. But the given case and study of Warren Buffet explains it wrong. Warren Buffet believes that the share price of a particular company could be controlled by the inventors by selling bulk shares or buying bulk shares at any time (Watson and Head, 2016).

It explains that the theory of EMH is highly controversial. People believe that technical and fundamental analysis is pointless while evaluating a stock’s price. If the EMH theory explains that the stock price could not be overvalued or under value than it was never possible for Warren Buffet to set market indices of 11.16% per year. Warren Buffet believes that it is not possible for any organization to maintain and manage the stock price (Frisch and Kolaric, 2014). Stock price of an organization could be up and down with the trend of buying the stock or selling the stock.

Further, it has been argued by Spyridon, (2016) that a market could never be efficient as the stock price of an organization never depends on the organization’s performance and the position of the organization. However, Kauffman, Spaulding and Wood, (2009) has reported against to it and depicted that the inside changes and good performance of an organization always enhances the stock price of an organization and vice versa. EMH theory assumes that the relevant information about an organization should be full and reflects the relevant information of the company correctly (Malkiel, 2003). Formally, there a capital market could only be efficient if the stock price of an organization is never unaffected after disclosing all the information.

Most of the analyst has believed that EMH theory is based on many assumptions and thus, it should not be concerned while making an investment into the stock market.  Further, it has been added by Frisch and Kolaric, (2014) that future analyst should evaluate, analyze and disclose the new method of investment as security market could never be efficient. Though, Marwala and Evan (2018) has claimed that if the stock price of an organization is undervalued than stock market should stop the trade of that stock for some time, it would help the market to be efficient and with the help of it, the securities could be traded in fair value. Warren Buffet has expressed his thought about stock and said that investors should never be emotional about its investment and must invest crucially as investor could be emotional to stocks but stocks would never be emotional for the investors (Degutis and Novickyte, 2014).

Different forms of EMH

Thus, the warren Buffet case and the study on various articles about the EMH theory explain that capital market could never be efficient. EMH theory is based on many assumptions and thus it does not offer a good conclusion to the investor. An investor should think crucially while investing into the stock.

For evaluating the efficient market hypothesis in a better way, UK stock, BHP Billiton stock, has been analyzed and compared with the FTSE index to evaluate that how much market is efficient and how the stock price and return of FTSE index is impacting on the BHP Billiton stock. The Below given figure explains that the market return of BHP Billion and FTSE are changing rapidly. Though, it has been evaluated that the returns of BHP Billiton is changing on a higher level whereas the return of FTSE stock is changing at a lower level (Watson and Head, 2016).

It explains that the weak form of efficiency is there among FTSE returns and BHP Billiton returns. Through the analysis on both the stock, it has been evaluated that on 1-7-2014, the return of BHP Billiton has been enhanced by 3.86% and on the other hand, FTSE return has been enhanced by 4.29%, it explains that the market was quite efficient. Through, on 1-1-2018, the return of BHP Billiton has been decreased by 5.14% and on the other hand, FTSE return has been enhanced by 4.36%, it explains that the stock is independent as well as the market is not efficient (Yahoo Finance, 2018).

The study on both the stock and market return explains that the market could never be efficient. The changes and the trend of security decide the stock price of an organization. It has been found that the insider changes and the investor choice is the significant reason behind the changes into the return of BHP Billiton.

Conclusion:

To conclude, the warren Buffet case and the study on various articles about the EMH theory explain that capital market could never be efficient. An investor should think crucially while investing into the stock.    

References:

And Increases In The South African Stock Market: A Note On Market.International

Business and Economics Research Journal, 04/2014, Volume 13, Issue 3

Degutis, A. and Novickyte, L., 2014. The efficient market hypothesis: a critical review of literature and methodology. Ekonomika, 93(2), p.7.

Frisch,T. and Kolaric, S. D. 2014. ReturnsOn Large Stock Price Declines

Hamid, K., Suleman, M.T., Ali Shah, S.Z., Akash, I. and Shahid, R., 2017. Testing the weak form of efficient market hypothesis: Empirical evidence from Asia-Pacific markets.

Kauffman, R. J; Spaulding, T. J;  and Wood, C. A. 2009 .Are online auction marketsefficient? An empirical study of market liquidity and abnormalreturns. Decision Support Systems, 2009, Volume 48, Issue 1.

Malkiel, B,G. 2003. The EfficientMarketHypothesis and Its Critics .The Journal of Economic Perspectives, 03/2003, Volume 17, Issue 1

Marwala, T. and Evan H. "Efficient Market Hypothesis." Artificial Intelligence and Economic Theory: Skynet in the Market. Springer, Cham, 2017. 101-110.

Narayan, P.K., Narayan, S., Popp, S. and Ali Ahmed, H., 2015. Is the efficient market hypothesis day-of-the-week dependent? Evidence from the banking sector. Applied Economics, 47(23), pp.2359-2378.

Spyridon ,R. 2016.Abnormal stock returns in Greece during the Cypriot banking crisis  Journal of Money Laundering Control, 05/2016, Volume 19, Issue 2

Timmermann, A and Granger, C. 2004. Efficientmarkethypothesis and forecastingW.J International Journal of Forecasting, 2004, Volume 20, Issue 1

Watson,D  and Head, A. 2016.Corporate Finance: Principles and Practice 7th Edition .Prentice Hall.

Yahoo Finance. 2018. BHP Billiton. [Online]. Available at: https://in.finance.yahoo.com/quote/BHP/history?p=BHP [Accessed as on 6th Feb 2018

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