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1. Introduction
One of the most contested issues in the finance literature has been the efficient market hypothesis (EMH) proposed by Fama (1970). After its early acceptability, few cracks began to appear in EMH which questioned the validity of the concept of informationally efficient markets in practice. EMH has undergone numerous tests to examine its validity in the financial markets, but a consensus has never been reached. This has led to a polarization among academics either defending EMH or favoring the behavioral biases that might influence the financial markets. In an attempt to reconcile these two schools of thought, Lo (2004) proposed the adaptive markets hypothesis (AMH) taking into consideration an evolutionary perspective of human behavior that influences the informational efficiency of markets. Under AMH, the level of informational efficiency of markets depends upon the ability of market participants to adapt to the changing market conditions.
The purpose of this study is to critically examine the empirical evidence of EMH that pose challenges to the concept of perpetual informational efficiency of financial markets and to provide a context in which a better understanding of behavioral biases can be attained through the evolutionary perspective provided by AMH. We critically examine the defence proffered to various anomalies of EMH and re-emphasize on the weaknesses in the justification provided to reinstate the confidence in the concept of informational efficiency of markets. AMH has generated lot of interest in recent years, as it provides a framework for reconciliation of contradictions between EMH and behavioral biases. In the real-world financial markets, there are uncertainties about the ability of stock prices to fully reflect all available information corroborated by the occurrence of booms and crises along with persistent attempts of market participants to gain informational advantage. We furnish the utility of AMH in illustrating the continually evolving market conditions in which absolute efficiency and outright irrationality are two extremes. Specifically, we provide a description of empirical studies that analyze the practicality of AMH by examining varying levels of efficiency in various stock markets.
The amount of literature pertaining to the concept of informational efficiency of stock markets is so vast that a full coverage of this issue is beyond the scope of this paper. Thus, we focus on reviewing the literature...