Random Walk Theory, Efficient Market Hypothesis (EMH), Securitisation, and Risk Modelling Technique

Risk, Portfolio, and Investment Analysis
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Risk, Portfolio, and Investment Analysis
Question 3
Over the years, there has been an increase in the demand for understanding share prices. The need to understand has made people have various questions regarding stock prices. One common question people have been asking is if Efficient Market Hypothesis (EMH) and random walk theory hold, there will be room for active fund management. One of the best ways that can help to understand this question is through understanding these terms. The random walking theory highlights that asset price changes are usually random, which means that since stock prices move unpredictably, it is hard for past prices to be applied accurately in predicting future prices (CFI Team, 2023). This theory means the stock market is efficient since it offers all the available information. This theory has challenged the common notion that sometimes can use technical analysis to identify profit by checking stock price patterns and trends.
On the other hand, EMH states that the share prices usually show all the information while making alpha generation impossible. Therefore, The EMH highlights that stocks usually trade at fair exchange values, a process that makes it hard for investors to purchase undervalued stocks (Downey, 2023). It also highlights that it is hard for investors to sell their stocks at higher prices which can be inflated. This hypothesis suggests that it is usually impossible to outperform the overall market by employing market timing or stock selection. This, therefore, highlights that the only way the investor can attain higher returns is by buying riskier investments.
The other critical term to understand is active fund management. Active fund management is choosing investments to offer a performance that beats the fund's stated index or benchmark (Chen, 2022). This approach involves a team of researchers who 'actively' buy and sell the stocks to maximize profits. Whenever the random walk theory and EMH hold, it is evident that there is no room for active fund management. For instance, the random walk challenge has highlighted that using technical analysis to maximize profit is impossible since it is impossible to beat the market without assuming additional risks (Smith, 2023). Similarly, EMH discourages using experts since it highlights that investors must not be rational since they usually act randomly (Thune, 2021). Furthermore, it highlights that it is impossible to outperform the overall market by employing expert selection since it emphasizes that investors can get higher returns by only purchasing riskier investments.
Question 4
The 2007-08 crisis was one of the worst financial crisis ever experienced since the 1929 Great Depression. This period threatened to damage the international financial system contributing to the failure of numerous major commercial and investment banks, insurance companies, and mortgage lenders. Securitization, especially the packaging of mortgage debt to bond-like financial instruments, was responsible for the 2007-08 financial crisis. This paper reflects on the role of securitization during this per...