Efficient Market Hypothesis and the NO arbitrage condition

Efficient Market Hypothesis and the NO arbitrage condition

The principle of no arbitrage conditions states that market participants cannot claim a risk-free return/profit unless there are conditions that facilitate to those claims.  The no arbitrage rule maintains a key position in analysing price and price movements in the financial markets as well as being a central component of such theories and concepts as efficient market hypothesis, arbitrage pricing theory and option pricing. It affirms that no arbitrage is not about every market participant to be fully rational and gain more profits relative to each other but points out that every decision marker once accesses sufficient funds and notices price imperfections will eliminate them immediately. However, due to ‘arbitrage limits’ it might be going the way when investors, even after spotting an arbitrage, won’t be able to fully fix this mispricing.  On the contrary a little research proves otherwise and gives a clear view on how the vast majority of market participants is willing to notice and exploit price imperfections as doing so will prevent from huge riskless profits made in the market, no matter what is one’s or another’s objective belief.

Going further into more deep and precise description, we bump into Efficient Market Hypothesis, which in fact can be considered a NO arbitrage hypothesis within the perfect market conditions (market integration).

In an informationally-correct market price fluctuations (or price movements) should not be predictable once they are properly anticipated. In other words, investors have to expect the very same price for the underlying asset while having the identical access to the available information set. Also, the Efficient Market Hypothesis’s (EMH) concept has a counter-intuitive side to the abovementioned statement: the more efficient the market, the sequence of price movements has the more random effect and in the most efficient market the price changes are completely random and cannot be properly forecasted. This is not the problem of nature but is the direct outcome of market participants’ activities that attempt to seize profit opportunities from the information they keep. Given that facts investors could pounce of even the smallest market imperfections (which can be considered as information advantages) and quickly eliminate them. If this happens instantaneously, then the prices must reflect available information set in any manner.  As such, no risk-free profits can be generated from information as all these profits should have yet been captured.  In other words, the asset prices are now following martingales.

The EMH concept has been presented not only in the financial market nature but also in the other directions that impact the co-integration of traded assets. The extensions cover incorporation of non-traded assets including human capital, transaction costs, asymmetric information, heterogeneous investors as well as state-dependent preferences and legal norms. All those aspects will help us identify the true nature of no-arbitrage opportunities throughout the selected world stock exchanges and prove whether market integration does really exist or not.

Add a Comment

Your email address will not be published. Required fields are marked *