Part 1Which of the following is an argument in favor of the efficient market hypothesis LOADING... ?Part 2
A. Over the long term, stock prices follow a random walk and do resemble their underlying fundamental value. B. Excessive volatility in stock prices as observed in 1987 and 2000-2001. C. Mean reversion of stock prices. D. Observed behavior in reaction to the "January effect."

Question

Part 1Which of the following is an argument in favor of the efficient market hypothesis LOADING... ​?Part 2
A. Over the long​ term, stock prices follow a random walk and do resemble their underlying fundamental value. B. Excessive volatility in stock prices as observed in 1987 and​ 2000-2001. C. Mean reversion of stock prices. D. Observed behavior in reaction to the​ "January effect."

BlackTom AI · Accepted Answer

The question asks us to evaluate which statement supports the efficient market hypothesis (EMH).
Option A: 'Over the long term, stock prices follow a random walk and do resemble their underlying fundamental value.' This aligns with the EMH idea that prices incorporate available information quickly and, over time, move in a manner consistent with random walk in the short run, reflecting fundamentals in the long run. In other words, price changes are unpredictable and reflect information, which is consistent with EMH.
Option B: 'Excessive volatility in stock prices as observed in 1987 and 2000-2001.' This describes episodes of large price swings that appear inconsistent with a perfectly efficient market, where price changes should reflect new information promptly but not exhibit systematic, extraordinarily large deviations without new information. Such events are often used to critique or question market efficiency, so this statement does not support EMH.
Option C: 'Mean reversion of stock prices.' Mean reversion suggests prices move back toward a long-run average over time. While mean reversion can be observed in some contexts or asset classes, it implies predictable reversion to a norm, which contradicts the EMH’s assertion that prices reflect all available information and that price changes are largely unpredictable. This is more at odds with EMH.
Option D: 'Observed behavior in reaction to the "January effect."' The January effect refers to a calendar anomaly where stock returns are higher in January. If such predictable anomalies persist, they challenge the EMH, which posits that abnormal returns should not be reliably achievable after costs and risk adjustments. This option points to a phenomenon that EMH would struggle to account for, so it does not support EMH.
Overall, Option A provides the narrative most consistent with EMH, describing prices that align with fundamentals over the long run and exhibit random-walk-like behavior in the short run, whereas the other options point to patterns or anomalies that are typically used to critique or question market efficiency.

Homework:Chapter 7 Homework

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