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Global Financial Crisis and Market Efficiency
Ray Ball proposes several lessons about market efficiency that people can learn from the global financial crisis. Among the lessons are the limitations to the efficient market hypothesis, which, according to Ball (2009), is silent on the supply side of the information market. This argument means that the theory of efficient market hypothesis does not present the facts such as the quantity of available information and its sources, which could include annual reports or governmental statistical reports. I agree with Balls allegation because the supply side of financial information is uncontrollable. Additionally, the data originating from the supply side is diverse, ranging from highly unreliable to explicitly reliable information. Companies that have smaller market capitalization experience low levels of corporate governance, hampering information quality.
According to Ball (2009), an efficient market hypothesis (EMH) is the interpretation of how stock prices relate to global market information. This theory assumes that security prices already incorporate and demonstrate significant information about the market. Ball (2009) uses three examples to justify this argument. First, he uses the concept of discounted present value, which the efficient market theory emphasizes. This method applies in a variety of contexts, including law, economics, business, accounting, and finance, and it underlies how people perceive the value of income streams. Besides, Ball (2009) states that the present value rule assumes efficient pricing of commodities. Its usefulness still prevails when an individual thinks and calculates the value of assets, liabilities, and a company at large.
The author also uses the legal theory of fraud on the market, which states that actors in an efficient market implicitly depend on stock prices that Ball (2009) assumes to incorporate all public information. I disagree with this theory because organizations play in small and medium ranges under poor governance, supplying insufficient information. The third theory proposes the use of market prices in valuation, especially when calculating net asset values (NAVs). Ball (2009) argues that finance in NAVs relies on the prices of securities that bind the invested funds. This method of valuation is consistent with the efficient market hypothesis theory because it is on the silent-side of liquidity aspects.
It is interesting to note that if financial regulators rely on the efficient market hypothesis. The regulators would portray skepticism of the unusually high returns of the financial crisis if they assume that financial markets are rational and efficient. The basic tenet of EMH is that stocks are always trading at their fair value. This tenet was ignored because regulators did not notice the abnormally high income that large financial institutions reported during the financial crisis. Besides, I disagree with Ball (2009) when he argues about the shape that the distribution of financial securities returns takes. The theory of efficient market hypothesis does not imply a repeat of distribution past return. However, they will recur in the future, and investors should not apply this information to make investment decisions or to develop minimum variance predictions.
Balls (2009) article shows that corporate financial managers should clearly understand the basics of EMH for its appropriate application. As such, the managers should consult this theory when deciding on capital budgeting, raising capital, as well as paying dividends. EMHs application lies on the premise that it is an abstraction that cannot. Balls explanations also imply that the demand side of information is among the weak points of EMH. Hence, the information is unreliable in corporate financial management at all circumstances in the stock market.
Reference
Ball, R. (2009). The global financial crisis and the efficient market hypothesis: what have we learned? Journal of Applied Corporate Finance, 21(4), 8-16.
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