Dissertation Writing Help on Efficient Market Hypothesis (EMH)- Financial Markets in India
Essay on The Chaotic Nature of Financial Markets
Finance Topics for MBA Project Reports
The simplicity of the Capital Market Theory (CMT) makes it ideal for an elementary appreciation of finance. However, the use of linear tools to model a non-linear world is questionable. Most systems we encounter, including those in nature, involve nonlinear structures, growth and development1. In the past, however, chiefly owing to constraints on computing power, it made sense for economists and mathematicians to use linear methods of modelling and forecasting for financial markets. This led them to rely on Euclidean objects such as lines, planes and three-dimensional space as their tools of analysis. The advent of computers gave mathematicians the ability to model complex systems without relying on simplified assumptions. Yet, although they had new tools to experiment with, mathematicians still continued to use old models in most situations. By
the 1970s, nonlinear methods of analysis had already been introduced in many fields of study including physics, biology, chemistry, electrical engineering, and sociology; however, although financial markets seemed to exhibit many chaotic tendencies, the concept of nonlinearity was not accepted by the community of financial analysts. One rationale for this resistance is that the acceptance of a new paradigm would throw out more than 40 years of work, and such a disruption would completely change the way analysts conducted their business. Ergo, the analysts’ only recourse was to continuously introduce additional theories and variations of the Efficient Market Hypothesis (EMH) to explain market inconsistencies. The only problem was that the backbone of these new theories relied heavily on the correctness of the EMH, which was far from correct. Development of EMH The development of the EMH2 was based on certain questionable assumptions. Chief among these were a normal distribution of returns and the concept of the rational investor. Later, data was presented in such a way as to conform and thus support this model.
The first set of statistical methods for analysingthe returns of stocks, bonds, futures, and options was offered by Louis Bachelier. Bachelier’s insight was revolutionary for his time, yet he received little recognition for his efforts. The statistical methods he had developed along with his analysis of returns remained largely forgotten until the 1940s when research efforts intensified.
In 1964, The Random Character of Stock Market Prices, an anthology compiled by P Cootner, was
published, which became the basis for the EMH. By this time, economists were primarily divided into three schools of thought: Technicians (who believed that investors behaved rationally); Fundamentalists (who largely followed Keynes and believed that the market was driven by emotion); and Quantitative Analysts or Quants, who fell somewhere between these two but had a bias toward the Fundamentalists.
In fact, changes in the prices of securities behaved nearly as if they had been generated by a suitably designed roulette wheel for which each outcome was statistically independent of past history and for which relative frequencies were reasonably stable through time. In other words, if we view the market as a perfect roulette wheel, there would be independence among variables and the probabilities must be stable over time. This conforms to the change model. The rationale for its acceptance is that if the market were an imperfect roulette wheel, people would notice the imperfections and by acting on them, remove them. Osborne developed the Random Walk theory in 1964. In it, he compared the movement of stock prices to the particle movement through a fluid – a phenomenon known as Brownian motion. In formulating this theory he drew upon a number of assumptions including:
- The price movements in the market are minimal
- The price of an asset is related to its underlying value
- The logical decision is always to pick the asset with the highest expected return
- Buyers and sellers will only trade at a mutually advantageous price: equilibrium.
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