Financial Markets Master Essay Example | Topics and Well Written Essays - 2250 words

Financial Markets Master - Essay Example In comparison to their peaks at the end of 2007, the Dow Jones Industrial Average Index and the DAX index have dropped almost 50% in value. Considering recent events many investors have reconsidered the concept of fair value of a stock and the efficiency of techniques used. In addition to this, the approach applied by many academics on Technical and Fundamental Analysis1 and of Efficient Market Hypothesis theory, rather than on how to forecast, has induced us to base the structure of this essay on a similar approach. Therefore in Section 1, 2 and 3 after providing a brief overview of FA and of TA the EMH theory, we have explored alternative views and discussed the validity of the statement in object. After illustrating the need for analysts to create efficiency in Section 4 we have explored the extent to which FA, TA or EMH may be essential to achieve market efficiency. Finally, after examining in Section 5 the Stiglitz-Grossman paradox, in Section 6, we have explored anomalies and i nvalidities of EMH and presented our conclusions. FA found its existence in the firm-foundation theory developed in the 1930s though it was later popularised by Graham. Its purpose is to find and explore all economic variables measuring different economic circumstances and influencing the future earnings of an economic asset. Clearly the philosophy behind FA is that in the end, when enough traders realize that the market is not correctly pricing the asset, the market mechanism of demand/supply, will force the price of the asset to converge to its fundamental value. Early writers on the subject of security analysis assumed that the essence of investing was to determine the "true," "intrinsic," or "fundamental" value of a security and that this value could differ from the current market price. Graham and Dodd (1934) first highlighted the concept of the intrinsic value of a security as a function of the future earnings of a company, rather than "book value". Implicit in their approach to the evaluation of securities was the assumption that some investors have better information than others and therefore can accumulate underpriced securities without a significant and self-defeating impact on the market price of the stock. This assumption turned out to be critical in understanding both the development of the EMH and the recent literature on market-making mechanisms. This approach tries to generate an abnormal return by analyzing fundamental factors of a company to be able to draw a comparison between the theoretically justified fair value and the actual stock market price2. These fundamental factors are derived by analysing public information, on the ground of which the FA can generate an abnormal return, because all public information is already correctly processed by the stock market and therefore correctly reflected by the actual stock market prices3. 2. TA: theory overview and statement assessment A second approach to choosing securities is termed TA or "charting", which plots the history of past prices and tries to discern some predictive pattern for future price movements as illustrated by Exhibit 1. This theory, developed at beginning of the