Fractal Market Hypothesis Vs Efficient Market Hypothesis: Applying ...

[Pallas_Boreas]

FRACTAL MARKET HYPOTHESIS VS. EFFICIENT MARKET HYPOTHESIS: APPLYING THE R/S ANALYSIS ON THE ROMANIAN CAPITAL MARKET - https://doi.org/10.47743/jopafl-2022-23-17

Introduction

The purpose of the paper was to present theoretical implications of the FMH and to apply R/S analysis on the historical time series of company Alro S.A. The results of the analysis indicate translation from an antipersistent trend, going to a random walk phase and reaching a persistent trend phase. The Hurst Exponent indicate the presence of a longterm memory effect, in the case H is different from 0.5. As the value of this metric is 0.5, it detects the independence of the studied series, but offers no indications about distribution. Classical statistical and econometric theory, intended to provide functional forecasting models in capital markets, is the mathematical foundation for a number of theories - efficient market theory, Harry Markowitz's optimized portfolio theory, the CAPM model developed by Sharpe, and the modern theory of portfolio - Modern Portfolio Theory (MPT).

There are suggestions among capital market theorists that efficient market hypothesis has only one function, which is to justify the use of probabilistic calculus in the analysis of capital markets. Specifically, the fame of this theory is demonstrated by thousands of studies and tests performed on it, being one of the most controversial theories, due to the ambiguity and general distrust under which the results are - confirmation of the efficient market hypothesis, with a certain statistical probability, it does not necessarily mean the efficiency of the capital market, but the fact that it tends to become efficient (and subsequently may result in the use of predictability models may be useless), and the rejection of the efficient market hypothesis does not necessarily mean that the market is inefficient.

From mathematical perspective, the very first formulation for EMH was the random walk version, being also the most restrictive version. Market efficiency does not necessarily imply a random walk, but a random walk implies for sure market efficiency. Alternatively, the independence assumption between market moves conducted to a more general martingale or submartingale models for market efficient hypothesis. One of the theories that fundamentally marked the modeling of financial phenomena is the efficient market hypothesis (Fama, 1970), according to which in an efficient market prices always correctly and completely reflect the available information. A particular form of efficiency, weak form efficiency, has the effect that trading prices follow a random walk pattern and returns are unpredictable. Guerrien and Gun (2011) take an extremely critical position against the efficient market hypothesis, showing that the idea of an efficient market cannot be valid from the point of view of Pareto optimality, as the conditions to be met in this regard are too restrictive.

Another widely spread idea among specialists is that in an efficient market it would not be possible to form speculative bubbles, or the formation of a speculative bubble market regime (Abreu and Brunnermeier, 2003), or they are quite common in recent history of capital markets. Malkiel (2011) refines the discussion on the relationship between the efficient market hypothesis and the financial crisis, dismantling much of the criticism of this hypothesis. Malkiel highlights the two main implications of the hypothesis: the fact that public information is reflected in price without delay, and the lack of opportunities for arbitrage. The author points out that in an efficient market prices are not always "correct" and not all investors necessarily behave rationally. Moreover, the fact that the trading price is "fair" refers to the fact that, according to the efficient market assumption, it is impossible to assess whether the price is undervalued or overvalued at any given time, which is an area dominated by uncertainty.