Environment of Global Financial Crisis

The global financial crisis of 2008-2009 left many economies damaged. The crisis had also shaken many viable financial theories, many of which relied on the sole assumption and belief that our markets were completely efficient. Many critics even went on to say that the EMH was more or less the only reason which was responsible for the financial crisis. Therefore, it’s important to understand what the EMH finanace means and what it doesn’t. The critics use far too restrictive approach to the EMH, in that because the stock prices are not always correct. As prices are always wrong, no one knows if they are too low or too high to be able to get a clear prediction. The EMH theory does not imply that the bubbles or trends in asset prices are impossible to have nor does it state that behavioural and environmental factors cannot have any effect or influence on the ROI or risk premiums. The core policy basically states that “arbitrage opportunities for riskless gains do not exist in an efficient functioning market and if they do appear from time to time they do not persist”.

These bubbles or trends are deemed very dangerous when they are incorporated with financial debt. In this case, in the financial crisis of 2008 – 2009, there was a housing bubble as well along with its associated derivates which left the financial sector severely damaged along with the consumers. Policymakers cannot predict these bubble sin advance; however, they can focus better on price-asset increases or decreases which are essentially financed with debt.even went on to say that the “belief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history. And efficient market theory also played a role in inflating that bubble in the first place.”

The EMH is essentially made up of two fundamental tenets. It first states that any information which is public is without any delay, reflected in asset prices. This implies that any information which adversely or beneficially impacts any future financial instrument’s price is going to be reflected in the asset’s prices today. To make it simpler for understanding – If a pharmaceutical organisation sells $40 per share receives approval for a new and improved medicine research or an antibiotic that can or will give the company a $80 value tomorrow, the price of the same will move to $80 without any delay, and not over a period of time. This happens because the purchase of a stock below $80 will give them immediate profits and therefore market players can bid the price upto $80 without delaying the process further to get maximum benefits. It is also possible that the full nature of such information is not available immediately to the market participants. It can also be assumed that sale and profit cannot be predicted with any clarity and that the final value is amenable to different variations or estimates. This happens because some market players may underestimate or overestimate the ultimate significance of the approved drug. Therefore, in many cases, the market may overreact to the news. This aspect of the EMH theory presents a second tenet of hypothesis – which is also more fundamental. This aspect states that in an efficient market, no arbitrage opportunists exist.