The first hypothesis is Random Walk Hypothesis.

1. Random Walk Hypothesis

According to this hypothesis the security prices adjust themselves randomly this implies that predicting any changes in the security prices is out of question.

The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk (so price changes are random) and thus cannot be predicted. It is consistent with the efficient market hypothesis.

Second Hypothesis is Fair Game Deal Hypothesis.

2. Fair Game Deal Hypothesis

According to the fair game deal model the current prices in the security market reflect all the available information about that security and the expected return based on this price reflect the risk of that security.

An investment without a risk premium. That is, fair game describes an investment without a higher return for more risk accepted. Thus, an investor may take on higher risk without the possibility of higher return. Risk-averse investors tend to avoid these investments.

Third is Efficient Market Hypothesis.

3. Efficient Market Hypothesis

Features of Efficient markets or building blocks of efficient Market:

An efficient market should have:

  • Large number of competing profit maximizing players or participants that can be registered traders or dealers.
  • These participants should analyze and assign their own intrinsic value to the security and each one should have their independent evaluation.
  • Intrinsic value is determined by fundamental and technical analysis.
  • New information regarding the securities comes to the market in a random fashion.
  • The new information is adjusted in the security prices rapidly.

Before Efficient market hypothesis was developed by fama in 1970. Two other hypotheses were present and those hypotheses were determining the stock prices.

“The current price [of an investment] should reflect all available information…so prices should change only based on unexpected new information.”

Also read: 3 forms of efficient market hypothesis

corporate finance

September 25, 2019