2. The Efficient Markets Hypothesis (EMH) as formalized by Eugene Fama in 1970 describes an efficient capital market as one that is efficient in processing information, so that the prices of securities observed at any time are based on an unbiased evaluation of all information available at that time. In other words, the market quickly and correctly adjusts to new information which is assumed to be unpredictable and random.  a. Eugene Fama categorizes EMH in terms of three forms of efficiency. Describe each form of efficiency and provide an example of a type of analysis or type of information that would refute each one(6 marks)  b. In empirical tests of the EMH over the years, a number of anomalies have been found that question the conclusion of market efficiency. In some cases, these anomalies were temporary, in other cases they were persistent. Even in the cases when the anomalies persisted, the problem may not have been with EMH. Explain why that might be the case and describe how the Fama-French model provides an explanation that could be considered consistent with EMH (6 marks)

a. Eugene Fama's Efficient Market Hypothesis (EMH) is categorized into three forms of efficiency: weak form, semi-strong form, and strong form.

1. Weak Form Efficiency: This form suggests that all past prices of a stock are reflected in today's stock price. Therefore, technical analysis methods would not be able to predict future price changes. An example that would refute this would be if a trader could consistently make above-average returns by using past price data or trend analysis.

2. Semi-Strong Form Efficiency: This form suggests that all publicly available information is incorporated into a stock's current price. Not just past prices. Therefore, fundamental analysis would also not be able to predict future price changes. An example that would refute this would be if an investor could consistently make above-average returns by trading on new public information (e.g., earnings announcements).

3. Strong Form Efficiency: This form suggests that all information, public and private, is fully reflected in a stock's current price. Therefore, even insider information could not be used to generate above-average returns. An example that would refute this would be if a company insider could consistently make above-average returns by trading on private information.

b. Empirical tests of the EMH have indeed found anomalies that question market efficiency. However, these anomalies do not necessarily refute the EMH. This is because the EMH does not require that prices are always correct, only that they are unbiased, meaning that deviations from true value are random. Therefore, persistent anomalies could be due to chance rather than inefficiency.

The Fama-French model provides an explanation for these anomalies that is consistent with the EMH. The model suggests that higher expected returns can be explained by three factors: market risk, size of firms, and book-to-market values. These factors could cause persistent deviations from the market average, but they are risk factors that investors are compensated for, rather than inefficiencies that can be exploited for profit. Therefore, the existence of these factors does not necessarily refute the EMH.