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Financial Management - Behavior of Prices under Different Versions of EMH

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A strong form of EMH includes the effects on prices of all sorts of information, historical, published, and even non-published. This also includes the insider information as well as the information held by the directors or other senior officials of the company. Any sort of manoeuvrings of buyers and sellers will not impact prices, whatsoever. It is highly impossible to test this form of EMH even if the acquirer has insider information. The only possibility available is to buy or sell the holdings before the information of takeover is published or leaked.

So much so that creative accounting technique cannot influence the takeover bids under the strong form of EMH. Under this form, current prices will reflect the present value of future cash flows. Any price exceeding the net value of assets based on market prices under a strong form of EMH will entail goodwill value of the takeover deal. Evaluation of takeover bids under the different version of EMH EMH theory was introduced in the late sixties, and prior to that inefficiency was believed to exist in stock markets.

Financial economists have claimed that no hypothesis has been so extensively tested as EMH in economics and finance deals. “ In an efficient market, security prices behave as if they fully incorporate all existing information quickly and without bias. Market efficiency in EMH means that security prices reflect the aggregate impact of relevant information in an unbiased way and the adjustment to the new information is very rapid. ” (L S Powell, page 42) The EMH advocates that investors are rational and the new information immediately get reflected into stock prices. That way most investors or takeover bids cannot beat the market.

But there is a behaviour approach to this study as well that advocates that rationality plays no role in takeover bids and investors are motivated by greed, fear, and other emotions. If EMH theory is to be believed then the fundamental mechanism of pricing does not seem to work. A weak form of EMH suggests that the movement of pricing takes into account the impacts of past movements of pricing and the historical information.    

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