1. Introduction
Efficient Market Hypothesis and has attracted many debates in the financial community. While there are supporters who claim the existence of an efficient market, the occurrence of material profits earned by the likes of Warren Buffet in its last 40 years of trading and investment is given as proof of its non-existence. This report is aimed at finding out if the theory of Efficient Market Hypothesis is relevant to our markets, and how come Warren Buffet was able to earn such huge profits with an average of 11% higher returns per year from the same market. (Malkiel, 2003).
The report will analyze a European market and a stock regarding their returns in the last few years. The stock selected is Admiral Group PLC, and the index chosen in which it trades the FTSE 100 Index. The report will look at the period of June 2012 to June 2018 for any abnormal returns for this company.
2. Efficient Market Hypothesis:
The classic statements of the Hypothesis of Efficient Markets can be found in the Fama (1970). As per Fama, The Efficient Market can be defined as the market, which is participated by profit maximizes having rational competencies to predict the future price of the securities with information available freely to all participants. The competition between these participants leads to a point showing the actual price of the securities based on the actual information that emerged. (Watson and Head, 2016).
There are three types of the Efficient Market Hypothesis: Strong Efficiency Market Hypothesis, Weak Efficiency and Semi-Strong Efficiency Market Hypothesis. As presented by Fama, the strong form shows that the price has integration of all the information available. Semi-Strong Hypothesis assumes that the stock price integrates the public data available. The weak-form hypothesis shows that the prices of stock integrate data as contained in the historical price patterns.
In European Markets, research done on the existence of an efficient market has shown that these markets do not show any characteristics of an efficient market. The EMH Theory along with the random walk theory has been the cause of many debates in the financial community in the last 30 years. After the Fama (1970), studies on the stock returns show that the market does not show the patterns of the random walks and is not normally distributed emerged (Spyridon, 2016)
A study conducted in six stock markets of Europe for proof of a weak form of EMH has shown that there has been rejection regarding considering these efficient markets. The Hypothesis was found to be rejected in the daily data for Greece, UK, France and Portugal markets (Watson and Head, 2016).
3. The Arguments for and Against the EMH
Argument for
The arguments for the EMH believe that, with the dependence on the collective judgment of the market investors, mistakes are bound to happen. However, the proponents of the EMH believe that even though the stock market is not perfectly efficient, it does not mean it will never attain the position. If the market is not efficient, then there should be millions of anomalies in the historical pattern of stock prices. The proponents do not think that the market can be irrational as then the investors could have set up a long-term strategy for the exploitation of this advantage. They believe that the market cannot be beaten by the investors (Malkiel, 2003).
Arguments Against
Ten years passed after the publishing and dominance of the Fama exposition. However, a steady stream of studies conducted after some time either opposed the work of EMH or showed that it was not entirely proven then. The opponents of this hypothesis formed arguments which are critical. For instance, the assumptions that shareholders are all equally rational, and hence they invest intelligently are never supported by evidence (Frisch, Kolaric and Schiereck, 2014). On the contrary, it is known that investors are widely affected by the inclination to chum their portfolios, or for asymmetrical judgments on the reasons of profits and losses or having the tendency to overreact or under-react to information or having the herd instinct.
Other than this, many anomalies have been identified in the pattern of the shared values historically. The most recognized of these are.
a-Small-Firm Effect:
It is a major study of the US share return which was the first one to document the fact that smaller market capitalizations deliver higher returns as compared to the large capitalization companies.
b-The January Effect
The outperformance of smaller capitalization companies was majorly realized in succeeding Januarys. It is also a development which as per the EMH cannot be explained.
c-The Mean Reversion
The hypothesis states that an investor cannot make any excess returns from old information. The computation of the surplus return largely based on the accurate evaluation of the risk measures linked with the stock.
These are some examples of anomalies. The non-adjustment of information in time, cash flow adjustments, and overreaction of market, tax treatment difference, and behavioral constraints of investors can be some of the causes (Latif et al., 2011).
The EMH theory does not believe in the winning strategy which can create abnormal returns. But the strategy employed by Buffet cannot be attributed to using the right strategy only. The explanation of Warren Buffet’s success can only be backed by the fact that Buffet followed an investment approach accompanied by suitable circumstances which became his competitive advantage. The outstanding abilities, along with the access to information and legal structure of the business are important factors which contributed to his success (Timmermann and Granger, 2004). The proponents of the EMH theory cannot find any reason for the Buffet success, but if they go beyond the theory and analyze the real world, not through the lens of this theory. The competitive advantage, the uniqueness of his circumstances, and the application of the value investing approach provides evidence for the legitimization of the case (Kauffman, Spaulding and Wood, 2009).
4. Admiral
The calculation for the returns of the market of the FTSE 100 Index and Admiral Stock for the five years from 2013 to 2017 shows the following pattern of price movement. The Total Return for FTSE in the last five years is 19%, while for Admiral Company is 69% (Appendix A). The difference can be seen as huge. Similarly, Appendix C shows that the Admiral Company is showing extreme impacts as compared to the index showing its high leverage position. The higher return is higher for Admiral as compared to the FTSE index higher as depicted in Appendix D.
Figure 1: Annual FTSE 100 and Admiral Returns Taken from Uk.investing.com (2018)
Figure 2: Monthly FTSE 100 and Admiral Returns Taken from Uk.investing.com (2018)
The figure 2 shows that the FTSE returns, and the Admiral Returns have a similar pattern. However, this figure is condensing the differences of the prices in a short space. The bar chart shown in Appendix D shows how much variance is present in the returns of both index and Admiral Stock. The stock highs and low are much higher and lower as compared to the Index because of its higher returns and higher risk represented in the variance value of 0.27% as compared to index’s variance of 0.09%.
5. Conclusion
To conclude, it can be said that investors want most profitable investments. The EMH, even though, seems to be a simple theory has not the ability to explain the effects of abnormal returns for Warren Buffet and other investors while remaining in its context. The only explanation is that the stock market is inefficient as described in the EMH and not all investors enjoy a similar position to access information.
6. References
Frisch, T., Kolaric, S. and Schiereck, D. (2014) ‘Returns on Large Stock Price Declines and Increases in the South African Stock Market: A Note on Market Efficiency’, International Business & Economics Research Journal, vol. 13, no. 3, pp. 581-592.
Kauffman, R.J., Spaulding, T.J. and Wood, C.A. (2009) ‘Are online auction markets efficient? An empirical study of market liquidity and abnormal returns’, Decision Support Systems, vol. 48, no. 1, pp. 3-13.
Latif, M., Arshad, S., Fatima, M. and Farooq, S. (2011) ‘Market Efficiency, Market Anomalies, Causes, Evidence, and Some Behavioral Aspects of Market Anomalies ‘, Research Journal of Finance and Accounting, vol. 2, no. 9, pp. 1-13.
Malkiel, B.G. (2003) ‘The Efficient Market Hypothesis and Its Critics’, Journal of Economic Perspectives, vol. 17, no. 1, pp. 59-82.
Spyridon, R. (2016) ‘Abnormal stock returns in Greece during the Cypriot banking’, Journal of Money Laundering Control, vol. 19, no. 2, pp. 122-129.
Timmermann, A. and Granger, C.W.J. (2004) ‘Efficient market hypothesis and forecasting’, International Journal of Forecasting, vol. 20, no. 1, pp. 15 – 27.
Uk.investing.com (2018) Admiral Group Plc, 2 June, [Online], Available: https://uk.investing.com/equities/admiral-group-historical-data [3 June 2018].
Uk.investing.com (2018) FTSE 100 Total Return, [Online], Available: https://uk.investing.com/indices/ftse-100-total-return-historical-data [3 June 2018].
Watson, D. and Head, A. (2016) Corporate Finance: Principles and Practice, 7th edition, Prentice Hall.
Appendix
A-Summary Table of Returns and Risk Calculation
| 2013-2017 | FTSE 100 | Admiral |
| Total Return | 19.23% | 69.87% |
| Mean Return | 0.73% | 1.25% |
| STDEV | 0.03 | 0.05 |
| Variance | 0.09% | 0.27% |
| FTSE Return | Admiral Return | |
| 2013 | -15.12% | 13.36% |
| 2014 | 0.01% | 12.51% |
| 2015 | -0.07% | -14.03% |
| 2016 | -13.29% | -8.67% |
| 2017 | -7.86% | -7.36% |
Summary Table of Returns and Risk Calculation has been taken from Uk.investing.com (2018)
B-Monthly Returns of FTSE 100 Index and Admiral Corporation 2013-2017
| FTSE Index Returns | Admiral Returns | ||||||
| Date | Price | Open | Change % | Price | Open | Change % | |
| 1-Jan-2013 | 4,844.11 | 4,884.75 | -0.83% | 1,083.58 | 1,045.48 | 5.43% | |
| 1-Feb-2013 | 4,884.75 | 4,681.76 | 4.34% | 1,108.39 | 1,082.70 | 2.29% | |
| 1-Mar-2013 | 4,681.76 | 4,640.72 | 0.88% | 1,180.16 | 1,110.16 | 6.48% | |
| 1-Apr-2013 | 4,640.72 | 4,757.16 | -2.45% | 1,134.97 | 1,181.04 | -3.83% | |
| 1-May-2013 | 4,757.16 | 4,462.54 | 6.60% | 1,185.47 | 1,100.42 | 4.45% | |
| 1-Jun-2013 | 4,462.54 | 4,710.30 | -5.26% | 1,175.73 | 1,180.16 | -0.82% | |
| 1-Jul-2013 | 4,710.30 | 4,581.82 | 2.84% | 1,243.06 | 1,177.50 | 5.73% | |
| 1-Aug-2013 | 4,580.29 | 4,554.78 | 0.56% | 1,117.25 | 1,245.72 | -10.12% | |
| 1-Sep-2013 | 4,554.78 | 4,495.42 | 1.32% | 1,115.45 | 1,124.34 | -0.16% | |
| 1-Oct-2013 | 4,495.42 | 4,416.75 | 1.78% | 1,157.06 | 1,110.02 | 3.73% | |
| 1-Nov-2013 | 4,416.75 | 4,146.58 | 6.52% | 1,124.49 | 1,159.78 | -2.81% | |
| 1-Dec-2013 | 4,146.40 | 4,122.47 | 0.58% | 1,185.11 | 1,126.30 | 5.39% | |
| 1-Jan-2014 | 5,071.34 | 4,919.51 | 3.09% | 1,242.78 | 1,161.93 | 6.61% | |
| 1-Feb-2014 | 4,919.51 | 4,969.42 | -0.99% | 1,165.69 | 1,255.00 | -7.12% | |
| 1-Mar-2014 | 4,968.88 | 5,110.75 | -2.78% | 1,255.00 | 1,204.23 | 4.05% | |
| 1-Apr-2014 | 5,110.75 | 5,007.81 | 2.06% | 1,206.11 | 1,229.15 | -1.95% | |
| 1-May-2014 | 5,007.81 | 5,013.61 | -0.12% | 1,230.07 | 1,341.56 | -8.37% | |
| 1-Jun-2014 | 5,013.61 | 5,076.74 | -1.24% | 1,342.48 | 1,434.62 | -5.94% | |
| 1-Jul-2014 | 5,076.74 | 5,008.21 | 1.37% | 1,427.25 | 1,347.09 | 6.24% | |
| 1-Aug-2014 | 5,008.21 | 4,858.11 | 3.09% | 1,343.41 | 1,298.26 | 4.29% | |
| 1-Sep-2014 | 4,858.11 | 4,989.17 | -2.63% | 1,288.12 | 1,299.09 | -0.29% | |
| 1-Oct-2014 | 4,989.17 | 4,750.05 | 5.03% | 1,291.86 | 1,281.00 | -0.49% | |
| 1-Nov-2014 | 4,750.05 | 4,920.23 | -3.46% | 1,298.19 | 1,302.71 | -0.69% | |
| 1-Dec-2014 | 4,920.23 | 4,844.11 | 1.57% | 1,307.24 | 1,189.63 | 10.31% | |
| 1-Jan-2015 | 4,976.07 | 4,959.95 | 0.32% | 1,612.59 | 1,583.43 | 2.34% | |
| 1-Feb-2015 | 4,959.95 | 4,717.08 | 5.17% | 1,575.65 | 1,563.01 | 0.50% | |
| 1-Mar-2015 | 4,715.95 | 4,854.74 | -2.86% | 1,567.87 | 1,468.73 | 7.39% | |
| 1-Apr-2015 | 4,854.74 | 5,162.51 | -5.96% | 1,459.98 | 1,482.46 | -1.52% | |
| 1-May-2015 | 5,162.51 | 5,023.82 | 2.76% | 1,482.46 | 1,408.81 | 4.66% | |
| 1-Jun-2015 | 5,023.82 | 5,367.57 | -6.40% | 1,416.47 | 1,325.61 | 6.78% | |
| 1-Jul-2015 | 5,367.57 | 5,329.14 | 0.72% | 1,326.56 | 1,430.81 | -6.85% | |
| 1-Aug-2015 | 5,329.14 | 5,166.30 | 3.15% | 1,424.12 | 1,484.38 | -2.77% | |
| 1-Sep-2015 | 5,166.30 | 5,269.20 | -1.95% | 1,464.63 | 1,433.61 | 1.83% | |
| 1-Oct-2015 | 5,269.20 | 5,099.79 | 3.32% | 1,438.31 | 1,385.67 | 3.73% | |
| 1-Nov-2015 | 5,099.79 | 4,956.78 | 2.89% | 1,386.61 | 1,360.29 | 1.86% | |
| 1-Dec-2015 | 4,956.47 | 5,071.33 | -2.27% | 1,361.23 | 1,250.30 | 9.53% | |
| 1-Jan-2016 | 5,527.00 | 5,640.37 | -2.01% | 1,827.00 | 1,888.00 | -3.89% | |
| 1-Feb-2016 | 5,640.37 | 5,582.74 | 1.03% | 1,901.00 | 1,920.00 | -0.83% | |
| 1-Mar-2016 | 5,582.74 | 5,485.02 | 1.80% | 1,917.00 | 2,047.00 | -6.44% | |
| 1-Apr-2016 | 5,483.94 | 5,393.88 | 1.67% | 2,049.00 | 2,038.82 | 1.23% | |
| 1-May-2016 | 5,393.88 | 5,214.61 | 3.44% | 2,024.01 | 2,140.52 | -5.27% | |
| 1-Jun-2016 | 5,214.61 | 4,979.35 | 4.72% | 2,136.57 | 2,025.00 | 6.60% | |
| 1-Jul-2016 | 4,979.35 | 4,964.16 | 0.31% | 2,004.27 | 1,942.07 | 3.15% | |
| 1-Aug-2016 | 4,964.16 | 4,894.50 | 1.42% | 1,943.05 | 1,885.73 | 7.65% | |
| 1-Sep-2016 | 4,894.50 | 4,808.71 | 1.78% | 1,805.05 | 1,908.08 | -6.35% | |
| 1-Oct-2016 | 4,808.71 | 4,769.44 | 0.82% | 1,927.52 | 1,680.63 | 14.49% | |
| 1-Nov-2016 | 4,769.44 | 4,890.97 | -2.48% | 1,683.54 | 1,732.15 | -2.37% | |
| 1-Dec-2016 | 4,890.97 | 4,976.07 | -1.71% | 1,724.37 | 1,596.06 | 6.93% | |
| 1-Jan-2017 | 6,207.69 | 6,320.67 | -1.79% | 2,002.00 | 1,917.00 | 4.11% | |
| 1-Feb-2017 | 6,320.67 | 6,207.92 | 1.82% | 1,923.00 | 1,925.00 | -0.05% | |
| 1-Mar-2017 | 6,207.92 | 6,249.85 | -0.67% | 1,924.00 | 1,819.00 | 5.89% | |
| 1-Apr-2017 | 6,249.85 | 6,149.33 | 1.63% | 1,817.00 | 1,908.40 | -4.99% | |
| 1-May-2017 | 6,149.33 | 6,096.92 | 0.86% | 1,912.36 | 2,054.97 | -6.62% | |
| 1-Jun-2017 | 6,096.92 | 6,254.24 | -2.44% | 2,048.04 | 1,983.67 | 3.24% | |
| 1-Jul-2017 | 6,249.32 | 5,956.51 | 4.92% | 1,983.67 | 2,022.29 | -2.62% | |
| 1-Aug-2017 | 5,956.51 | 6,036.73 | -1.33% | 2,037.00 | 1,978.11 | 3.08% | |
| 1-Sep-2017 | 6,036.73 | 5,969.78 | 1.12% | 1,976.15 | 1,957.48 | 1.11% | |
| 1-Oct-2017 | 5,969.78 | 5,790.76 | 3.09% | 1,954.53 | 1,798.28 | 8.81% | |
| 1-Nov-2017 | 5,790.76 | 5,823.91 | -0.57% | 1,796.32 | 1,748.17 | 1.14% | |
| 1-Dec-2017 | 5,823.91 | 5,527.99 | 5.37% | 1,776.00 | 1,835.00 | -2.79% | |
Table of Monthly Returns of FTSE 100 Index and Admiral Corporation 2013-2017 has been taken from Uk.investing.com (2018)
A-Line Graph showing the Monthly Returns for FTSE 100 Index and Admiral 2013-2017
Data for Line Graph showing the Monthly Returns has been taken from Uk.investing.com (2018)
B-Bar Graph showing the Monthly Returns for FTSE 100 Index and Admiral 2013-2017
Data for Bar Graph showing the Monthly Returns has been taken from Uk.investing.com (2018)
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