Discuss about the Efficient Market Hypothesis and Critics.
The content of this paper apply various financial aspects to give response the statement "If the business cycle is predictable, and a stock has a positive beta, the stock's returns also must be predictable”. In order give response to the above mentioned statement various financial models are applicable (Burton and Shah 2017). The justification of the statement depends on the analysis and application of efficient market hypothesis as a model in field of finance. Efficient market theory is a financial economic model which states that at any given period in an efficient or a liquid market, prices known as security prices vividly reflect all the available information in the market. The efficient market hypothesis therefore exist in three capacities as strong, semi strong and weak (Petkova and Zhang 2005).
From the definition of the efficient market hypothesis model, one can deduced an idea and respond to the statement, "If the business cycle is predictable, and a stock has a positive beta, the stock's returns also must be predictable”. It is therefore clear that in a case where positive beta stock responds quite well to the valuable and favorable new information concerning the business progress via a business cycle recoveries, the value of the stock’s returns should therefore be predictable without showing any form of abnormality based on the already speculated events (Malkiel 2013). For instance, in an event where a recovery is anticipated prior, the actual recovery in this case is not considered as a new information. The statement is therefore true since in such events where the recovery is already anticipated the cost of the available stock should reflect the forth coming recovery.
Determining the level of stock’s returns as strong, semi strong or weak is the only factor which cannot be predicted. The unpredictability of the stock too can only be evident when responding to new market information (Petkova and Zhang 2005). From the assumptions in the weak market where the prevailing stock prices reflect all the security market information at hand, the future stock can be predicted. The assumption is similar to that of a strong market and a semi strong market which concludes that excess stocks returns cannot be achieved using technical analysis.
Based on the above analysis and reflection to various efficient market hypothesis, it is evident that when the business cycle is predictable and the available stock has beta the future stock’s returns can be predicted (Malkiel 2013). This is because the future stock’s returns cannot be more than the available positive beta. As seen from the models explaining various levels of the market which concludes that future stock estimation cannot be exceeding the recoveries, the statement can therefore be classified as true (Burton and Shah 2017). And as previously stated, when a positive beta responds well to the business cycle predictions as well as the favorable new market information, the value of the future stock’s returns can be predicted. In conclusion, the statement “If the business cycle is predictable, and a stock has a positive beta, the stock's returns also must be predictable” is true as the value of stock’s returns can be predicted based on a positive beta and the predictable business cycle.
Burton, F.E.T. and Shah, S.N., 2017. Efficient Market Hypothesis. CMT Level I 2017: An Introduction to Technical Analysis.
Malkiel, B.G., 2013. The efficient market hypothesis and its critics. The Journal of Economic Perspectives, 17(1), pp.59-82.
Petkova, R. and Zhang, L., 2005. Is value riskier than growth?. Journal of Financial Economics, 78(1), pp.187-202.
Timmermann, A. and Granger, C.W., 2014. Efficient market hypothesis and forecasting. International Journal of forecasting, 20(1), pp.15-27