Financial Markets Assignment Essay Example | Topics and Well Written Essays - 2000 words

Financial Markets Assignment - Essay Example He classified it into three levels based on the definition of available information: weak, semi-strong and strong forms. He further suggested three models for testing market efficiency: the Fair Game model, the Submartingale model, and the Random Walk model. The weak form of EMH attracted all the attention of empirical research in both developed and emerging markets results. This is because if evidence fails to support the weak-from of EMH, stricter forms of EMH would consequently fail (Wong and Kwong, 1984). The weak form of EMH considers a market to be efficient if information contained in past prices is already reflected in current market prices. Information from historical prices would not enable market traders to make superior returns as this information is already accounted for in current prices. The semi-strong form of EMH considers a market to be efficient only if current market prices reflect all publicly available information, such as information on interest rates, dividends announcements, quarter and annual earnings, etc. Thus market traders would not make superior returns from analysis of market information because market prices will immediately adjust to new news. If all market information is immediately reflected in market prices, even private information (inside information) and market participants could not benefit from such knowledge, the market is referred to as strong form of EMH. This assumes that the cost of inside information is zero. This assumption does not exist in reality and thus the strong form of EMH is not likely to hold. Statistical Testing of EMH: The efficient market hypothesis was tested by a number o f statistical test such as autocorrelation, runs test and variance ratio tests. Data: The data used to test for weak form EMH was collected from Yahoo Finance (2008). Historical daily prices for British Petroleum from the British Stock Market were collected 1st of January 2003 to 3rd of November, 2008. This data contains opening price, daily high, daily low, closing price, daily traded volume, and an adjusted close price. Data representing the market is represented by the FTSE 100 British index. FTSE 100 is an index of the largest 100 firms in the UK based on market capitalization. Historical daily prices for FTSE 100 were collected from 1st of January 2003 to 3rd of November, 2008 from yahoo (2008). Daily return is computed by using the following equation: Return (rt) = closing price at any day (pt) - closing price at day before (pt-1) A natural logarithmic transformation is performed on all data of BP and FTSE 100. Daily returns are computed by using the following equation: Return (rt) = closing price at any day (pt) - closing price at day before (pt-1) To generate a time series of continuously compounded returns, daily returns are computed as follows: rt = log (pt) - log (pt-1) = log (pt/pt-1) Where return at some day: rt Closing Price at day (t): pt Closing price at day