Cassian Hand 12056901 Monday, 3pm

The Financial System

Written Reflection
What are your thoughts on the volatility of the stock markets across the
globe? Discuss whether you believe this volatility is consistent with an
efficient capital market?
Volatility relates to the amount of movement in a variable that can be calculated by
its variance around the average value. Volatility can be explained in stock markets
across the globe by understanding the Efficient Market Hypothesis, which implicates
that stock markets react quickly in response to price-sensitive information which
effectively generates stock prices that move randomly. Market variables propose risk
when they move erratically, since their movement cannot be predicted. Variables that
are more unpredictable are riskier while posing a superior potential for higher
returns. Graph 1 below depicts the growth in earnings of the S&P Index since 1969.
After each and every recession (portrayed by arrows), earnings recuperated
completely and proceeded to new highs. This representation also aligns with my own
personal experience trading on the ASX Share Market Game in 2015. At the
commencement of the game I put together a portfolio of around ten different stocks
listed on the S&P/ASX 200. Within the first week alone, my portfolio had dropped to
a low of around $46,000, however due to the volatility within the share market after
about five weeks the same portfolio had risen to a high of around $52,000. This is
depicted by Graph 2 and can once again be explained by the Efficient Market
Hypothesis in which prices tend to generally follow a random walk and their
movement cannot be consistently predicted.

Graph 1

Cassian Hand 12056901 Monday, 3pm

Graph 2
In my opinion, the aforementioned volatility is generally consistent with the stock
market being an efficient capital market, however the exception of bull and bear
markets and price bubbles lead me to believe that there are in fact periods where the
stock markets do not behave according to the theorys implications. A bull market
refers to long periods of generally rising prices, while a bear market refers to periods
where prices are generally falling. For example, Indias Bombay Stock Exchange
Index (BSE SENSEX) was in a bull market trend for above five years from April 2003
to January 2008 as it increased from 2,900 points to 21,000 points. These types of
markets blatantly contradict the Efficient Market Hypothesis as prices are expected
to change randomly and follow a random walk, which was assuredly not the case
with the aforementioned BSE SENSEX which consistently rose in price for five
years. Furthermore, price bubbles are phases where prices surpass fair values and
are tailed by a sharp rectification. As a result, it becomes evident that stock markets
sometimes generate prices that are too high or too low, which again does not align
with the theorys insinuations. An example of a price bubble was the US housing
bubble which lead to the Global Financial Crisis which is portrayed below in Graph 3.

Graph 3

Cassian Hand 12056901 Monday, 3pm

References:
Campbell, S. 2005, Stock market volatility and the great moderation, Finance
and Economics Discussion Series, pp. 1-5
Schwert, W. 1990, 'Stock market volatility', Financial Analysis Journal, MayJune pp. 23-34