On Monday Pound Sterling went down to 1.41 against US dollar, after announcing of Boris Johnson that he wants to campaign to leave EU on Sunday 21st of February. This is not something new and it was predicted that Boris Johnson would campaign for UK to leave European Union. People were aware of it for a while but yet the market did not respond to it as it did on Monday 22nd of February.
Efficient Market Hypothesis
In the last 30 years of last century, efficient market theory has been widely accepted and dominant in academic finance and economics. It is linked with “random walk”. According to Osborne (1964), the change of all stock prices is random and unpredictable. Because stock prices and exchange rates fully reflect all the information, if the information is changed, stock prices and exchange rates will immediately reflect the news. However, this information cannot be known in advance, the situation leads investors not to depend on previous stock prices and exchange rates to predict future prices and rates. Followed in 1965 and 1970, Eugene Fama for the first time mentioned the concept of efficient market. He made some assumptions that in the efficient market, there are a large number of rational investors who expect to obtain maximize returns. Every investor is able to acquire important information and tries to predict the future price of a single stock. Due to the intense competition among investors, this condition makes the market price of a single stock completely represent all the things in the whole time.
The latest news for UK to leave EU is weak form of efficient market.
In a weak form efficiency hypothesis, price of market securities can reflect historical information, including stock prices and exchange rates , trading volume, short selling amount, financing amount and so on. In this case, investors will fail to acquire abnormal return by forecasting stock prices movements from market information in the past. This means technical analysis is no longer helpful. Nevertheless, fundamental analysis can still result in abnormal returns. It was known that Boris Johnson wanted UK to leave European Union, but yet the market did not respond until Monday.