Financail Engineering And Derivatives

MSc Risk Management

Module: Financial Market   & Product Risk (RFSFM18)

Coursework 1

Topic: Discuss why active investment managers may believe that they can outperform their benchmark index in an “efficient market”

Karen Lockhart: Martic No. 200719375

Word Count 1471

Total Pages: 7

Active management is the art of stock picking and market timing with the objective of beating the benchmark index in an efficient market in order maximise profit. Examples of benchmark indices include, FTSE 100, FTSE 250, FTSE Techmark or the S&P 500 Index.

There are many who content that consistent and predicable success through active management is not possible. One such theory is the Efficient Market Hypothesis evolved via Eugene Fama in the 1960s. Fama persuasively made the argument that in an active market that includes many well-informed and intelligent investors, securities will be appropriately priced and reflect all available information and therefore no further available information or analysis which can be drawn upon which would be expected to result in outperformance of the given benchmark. The efficient-market hypothesis states that it is impossible to consistently outperform the market by using any information that the market already knows, except through luck.

There are three forms of the efficient market hypothesis. The weak-form asserts that all past market prices and data are fully reflected in securities prices, therefore technical analysis which claims the ability to forecast the direction of prices through past market data, primary price and volume is of no use. The second is semistrong-form asserts that all publicly available information is fully reflected in securities prices; therefore fundamental analysis which analyses financial statements, the health of the business, its management and its competitive advantage is of no use. The third is strong-form asserts that all information is fully reflected in securities prices and therefore even...