Securities pricing directly reflecting the information available at a given time form the foundation for the Efficient Market Hypothesis. Delineated by Eugene Fama in 1965, this theory has been at the forefront of financial economics in terms of theory, practice and discussion since its inception. Termed “noise”, Fama considered intrinsic values of political and social information extraneous to value in that no degree of certainty exists. In outlining his theory, Fama (1970) made a distinction between three forms of EMH: (a) the weak form, (b) the semi-strong form, and (c) the strong form.
The basis for most empirical research thus far has been the semi-strong form of EMH. Smidt (1968) determined Fama’s findings as plausible. In finding possible modes of non-randomness, he warns, would not imply the theorem is incorrect, but possibly the mode of discovery as flawed. He found three distinct sets of circumstances where price changes could be considered random: the information is itself random, all investors are informed of the exact same material, or time lags make the information inconsequential.
He looked into sources of systematic price tendencies and found that “liquidity, lags in response to new information and exaggerated responses to new information” sway the prices in the market, thus questioning the theories validity. In response to Fama’s 1965 piece, many scholars replied to this new position on market analysis. One such scholar, Robert A. Schwartz, did not distinctly state Fama as incorrect. He posed that more research into the actual passing of information required more attention, as well the method of empirical study employed.
In finding the terms of research for strong and semi-strong weak at best, Schwartz aligns himself to many studies done on the weak form. He posits that an all-inclusive test is needed to further provide cleat and distinct answers (1970). A third response to Fama’s suggestion came from Professor William Sharpe in 1970. Volatility, similar to Fama’s beta, served as Sharpe’s response to this proposition. In examining the risk of a given stock, one must consider changes in the whole market.
He called for extensive research in the area, and posed the obvious interest of corporate headquarters in accepting an efficient market as it affords comfort and stability for the investors, which the corporations depend on. In his book, “A Random Walk Down Wall Street”, originally published in 1973, Burton Malkiel takes small time investors and portfolio managers alike into the world of making it big in the stock market. This book, still in print, is marketed as one of the most important pieces of literature any investor needs.
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