The CAMP assumes all investors are well diversified and that specific company risk (called “non systemic” risk in the language of CAMP) is eliminated by holding a diversified portfolio. The investor is only left with “systemic” or general market risk (Banz, 1981).
The efficient market hypothesis asserts that investors cannot consistently “beat the market” because stocks reside in perpetual equilibrium (Badarinathi and Kochman, 1996). Supporters point to the 100,000+ analysts and traders whose collective actions ensure that the prices of the 3000 or so major stocks do not stray too far from their respective values.
According to the efficient market hypothesis, a market is efficient with respect to a particular set of information if it is impossible to make profits by trading on this set of information. The mechanism to make markets efficient is arbitrage and competitive action by sophisticated investors. However, the EMH does not prevent firms from earning economic rents, defined as profits that cover the opportunity cost of capital (Chen and Dodd, 2002).
The capital market accounting research briefly reviewed above is based on a maintained hypothesis of market efficiency, which allows researchers to test a relation between accounting information and stock prices under the null hypothesis of no relationship (Kothari, 2001). The assumed market efficiency implies that price is always equal to fundamental value, which explains the use of price as the criterion variable in the majority of market-based accounting studies. However, we share Dr. Paulo’s concern that evidence contradictory to market efficiency has been substantial. In fact, the evidence has not gone unnoticed in the accounting literature (Kothari, 2001; Lee 2001).
The efficient market hypothesis states that asset prices in financial markets should reflect all available information; as a consequence, prices should always be consistent with ‘fundamentals’ (Beechey, Gurne, and Vickery, 2000). The efficient market hypothesis is almost certainly the right place to start when thinking about asset price formation. The evidence suggests, however, that it cannot explain some important and worrying features of asset market behaviour (Beechey, Gurne, and Vickery, 2000).
Credit:ivythesis.typepad.com
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