Stock Investment and Excess Returns: A Critical Review in the Light of the Efficient Market Hypothesis

Round 1

Reviewer 1 Report

In this article the authors present a review on the literature that deals with (a) stock investment and excess returns and (b) the efficient market hypothesis (EMH). While the authors may invested many efforts in this work it is not clear to me where the focus of this paper is. My main concerns regarding this paper are (i) the structure of the paper (ii) and some quality issues.

Therefore, I would like to raise the following points.

1. Regarding the structure of the paper I believe that if the authors want to focus on the excess returns calculations then the EMH part should be reduced and a focus should be on the null models and the calculation/identification of excess returns. In this case I believe that a brief reference to the EMH and the joint hypothesis problem in the introduction section (or even in a brief section following the introduction) would be sufficient. Then the authors may be able to focus on the various null models (such as CAPM, APT etc) or procedures (such as bootstrap simulations) that can be used to calculate abnormal returns, and categorize them properly.

2. Regarding the quality issues, I personal believe that the use of English language is poor. The authors try to use impressive terminology and in some cases the words used are not appropriate. There are also many typos that make reading difficult. Perhaps the authors should consider giving the paper for proof reading by a native speaker. Below are just a few examples from the beginning of the paper.

a.       Line 26: I believe the word “fierce” is too strong and not appropriate to characterize the Efficient Market Hypothesis

b.       Line 30: replace “either” with “whether”

c.       Line 31- replace “un-predicable” with “unpredictable”

d.       Line 33- replace “Anoomaly” with “Anomaly”?

Some further points:

3.   Line 209: Arbitrage is about achieving riskless profit by simultaneously taking more than one positions. I believe that the use of this term in this paragraph is not appropriate.

4. Data used to produce figures 3a and 3b are not described (stocks of which market, period etc.).

5. Line 416: “Some other researchers”… should be replaced with specific references.

Author Response

Dear Editor and Reviewer：

We are grateful for the opportunity to revise and resubmit this manuscript. We have tried to address the reviewer’s concerns to the fullest extent possible. In response to specific feedbacks, we conducted careful modification and clarification. We believe that this revised manuscript is stronger as changes made in response to the feedbacks and hope you agree with this. For your convenience, the reviewer’s comments are reproduced with our highlightened responses following the comments. To keep the revised manuscript clearly readable, we highlight our major revisions and additions in colored texts, instead of keeping track of all minor changes of words or deletions at the same time. Please refer to the revised manuscript as well as our responses to the reviewer reports for the details. We have tried to rectify the English language problem by giving it to an English expert and he had make corrections according to sentence structure, punctuation, grammar and contextual spelling. We hope that the manuscript has appropriate English style and terminologies for readers. Further comments are also incorporated.

Again, we wish to thank the great help from the reviewers as well as the kind assistance from the editor.

Reply to Reviewer 1：

Comment1: Regarding the structure of the paper I believe that if the authors want to focus on the excess returns calculations then the EMH part should be reduced and a focus should be on the null models and the calculation/identification of excess returns. In this case I believe that a brief reference to the EMH and the joint hypothesis problem in the introduction section (or even in a brief section following the introduction) would be sufficient. Then the authors may be able to focus on the various null models (such as CAPM, APT etc) or procedures (such as bootstrap simulations) that can be used to calculate abnormal returns, and categorize them properly.

Reply: Thank you very much for the valuable and useful comments. Our focus is not limited to excess return calculations. Inclusion of EMH is necessary as our narrative review paper is based on this theory and for a narrative review paper it is necessary to start from the origination of relevant literature but we believe that EMH part can be reduced and we limited this part upto section 2. We have also modified section 3, this section deals with different Parameters and Models exist in literature. However, we cannot add procedures like bootstrap simulations because in this paper we only take those valuation models, which were widely used in the past literature, but later on they were unable to give true valuations of stocks. Modified pattern of section 3 as follows:

3. Early Valuation Parameters and Models used to Predict Excess Returns

3.1. Early valuation Parameters

               3.1.1.  Dividend Yield and Excess Returns

               3.1.2. Firm Size and Excess Returns

               3.1.3. Value Stocks and excess Returns

    3.2 Anomaly Returns and Valuation Models

              3.2.1. Capital Assets Pricing Model

              3.2.2. Fama & French 3 Factor Model

Comment 2:Regarding the quality issues, I personal believe that the use of English language is poor. The authors try to use impressive terminology and in some cases the words used are not appropriate. There are also many typos that make reading difficult. Perhaps the authors should consider giving the paper for proof reading by a native speaker. Below are just a few examples from the beginning of the paper.

Reply: Thank you so much for your valuable comments. We have tried to rectify the English language problem by giving it to an English expert and he had make corrections according to sentence structure, punctuation, grammar and contextual spelling. We hope that the manuscript have appropriate English style and terminologies for readers. Further comments are also incorporated.

Comment 3:

a.         Comment 3: Line 26: I believe the word “fierce” is too strong and not appropriate to characterize the Efficient Market Hypothesis

b.         Line 30: replace “either” with “whether”

c.         Line 31- replace “un-predicable” with “unpredictable”

d.         Line 33- replace “Anoomaly” with “Anomaly”?

Reply: Thank you so much for your valuable comments. We have changed your suggested inappropriate expressions and following incorporated changes are as follows.

a.     Word fierce is replaced with “Substantial”

b.     Word either is replaced with “Whether”

c.     un-predicable” is replaced with “unpredictable”

d.      “Anoomaly” is replaced  with “Anomaly”

Comment 4: Line 209: Arbitrage is about achieving riskless profit by simultaneously taking more than one positions. I believe that the use of this term in this paragraph is not appropriate.

Reply: Thank you so much for your comment. We agree with your comment and we have removed this inappropriate expression.

Comment 5: Data used to produce figures 3a and 3b are not described (stocks of which market, period etc.).

Reply: Sorry for inconvenience. We have removed this discrepancy and add complete detail of both figures:

Figure 3(a):Fama and French 25(portfolios ranked on the size and book-to-market) U.S. stocks 1963-2015average excess return to the FF 25 against the average excess return one would expect, given beta

Figure 3(b): Fama and French 25 (portfolios ranked on the size and book-to-market) U.S. stocks 1963-2015 actual excess returns and CAPM expected excess returns against estimated betas.

Comment 6: Line 416: “Some other researchers”… should be replaced with specific references.

Reply: Thank you so much for your comment. We have added references to make it appropriate sentence.

(Mclean and Pontiff 2016)(Liu and Zhang 2014)argued about distress premium that its inclusion in the three-factor model is either due to survivor bias or due to data snooping.

Reviewer 2 Report

This paper is theoretical and without any own study of the Authors. I recommend completing all studies connected to efficient market hypothsis and their evaluation into a table, because in current form the Authors' discussion is very unclear. Moreover, the main disadvantage of this work is the lack of Authors' own calculations/ research on efficient market hypothsis.

I found this article as a good introduction into the more complicated research, because the current version is only subject literature review with critical view indeed, but the value added of this paper is still quite low. I think that the Authors should state at the beginning of the paper that this dicussion is just a part of the larger research.

I recommed developing conclusions and pointing out the research areas that should be expanded in the future studies.

Author Response

Dear Editor and Reviewer：

We are grateful for the opportunity to revise and resubmit this manuscript. We have tried to address the reviewer’s concerns to the fullest extent possible. In response to specific feedbacks, we conducted careful modification and clarification. We believe that this revised manuscript is stronger as changes made in response to the feedbacks and hope you agree with this. For your convenience, the reviewer’s comments are reproduced with our highlightened responses following the comments. To keep the revised manuscript clearly readable, we highlight our major revisions and additions in colored texts, instead of keeping track of all minor changes of words or deletions at the same time. Please refer to the revised manuscript as well as our responses to the reviewer reports for the details. We have tried to rectify the English language problem by giving it to an English expert and he had make corrections according to sentence structure, punctuation, grammar and contextual spelling. We hope that the manuscript has appropriate English style and terminologies for readers. Further comments are also incorporated.

Again, we wish to thank the great help from the reviewers as well as the kind assistance from the editor.

Reply to Reviewer 2：

Comment1:

This paper is theoretical and without any own study of the Authors. I recommend completing all studies connected to efficient market hypothesis and their evaluation into a table, because in current form the Authors' discussion is very unclear.

Reply: Thank you very much for your comment. We have make the table for each section of the article and here you can see the tables of the article. Moreover, The later part of your comment is related to lack of own calculations and in reply to this comment I have already elaborate about the structure of narrative review article that it is a combination of published literature of the interested topic from its origination to current state of it.

Table 1. Selected work on Development of EMH

Table 2. Selected work on Critics of EMH and Modern state of EMH

Table 3. Selected work on Early Valuation Parameters and Excess Returns

Table 4. Selected work on Excess returns and Valuation Models

Table 5. Selected work on Reasons behind Cross Sectional Excess returns

Table 6. Selected work on Replication: A Futuristic Approach

Comment2:

Moreover, the main disadvantage of this work is the lack of Authors' own calculations/ research on efficient market hypothesis.

Reply: Thank you very much for the valuable and useful comments. We would like to make some clarifications as follows to help our theme/structure of paper better understood:

As it is a review article and review articles are classified into different types, this review article is “Narrative review article”. A narrative review explains the existing knowledge on a topic based on the published research available on the topic and generally summarize the existing literature on a topic in an attempt to explain the current state of understanding on the topic. Therefore, it is not necessary to have calculation based research in a narrative review article.

Comment 3: I found this article as a good introduction into the more complicated research, because the current version is only subject literature review with critical view indeed, but the value added of this paper is still quite low. I think that the Authors should state at the beginning of the paper that this discussion is just a part of the larger research.

R eply: Thank you so much for your valuable comment. The structure of a “Narrative Review Article” is mentioned above and by considering your comment, we have removed this discrepancy by adding this theoretical portion in introduction section:

According to EMH, there is no room for excess returns but later on, different anomalies found and investors gain excess returns even in the existence of EMH. Shortly, the literature finds a shred of evidence that these anomalies are weak in magnitude or sometimes their presence was just a falsification when these studies replicated. Therefore, this narrative review article is an attempt to address this issue in order to combine historic literature from every possible dimension and try to make it an extensive study of available evidence for researchers who are interested in doing their research in the particular field. Besides, this narrative review not only explains the existing knowledge of the topic based on the published research but also an attempt to explain the current state of understanding on the topic.

Comment 4:

I recommend developing conclusions and pointing out the research areas that should be expanded in the future studies.

Reply: Thank you so much for your comment. We have modified the conclusion according to your comment:

Evidence of cross sectional predictable patterns challenges the existing well-established asset pricing paradigm. Indeed, researchers should focus more on such type of models by considering the importance of behavioural aspects as well. Moreover, researchers must admit that the existing evidence regarding anomalies is not a constitutional proof and the established paradigms are wrong. The issue of data snooping, found in many types of research, gives an alarming indication regarding the reliability of these studies. Data snooping affects all aspects of return procedures, averages and variations with other anomalies and factors. Future research can gain advantage from the new historical sample to take more insights into asset prices.

Reviewer 3 Report

The paper “Stock investment and excess returns: a critical review in the light of the efficient market hypothesis” should analyze the anomaly returns in relation with the theory of efficient market, in a critical manner.

I do not find in the article the answer of these questions: Why is this research important? Who will be interested in your research? What are the results of your study?  

The article seems to be a literature review but only old articles are mentioned without be emphasized the relevant and new articles published in this field. Also the critical approach is missing from this article.

I recommend to the authors to rewrite the paper after a deeper analyses of all the relevant literature in this field and related with all the five hypotheses mentioned in the lines 52-63 from the introduction part.

Author Response

Dear Editor and Reviewer：

We are grateful for the opportunity to revise and resubmit this manuscript. We have tried to address the reviewer’s concerns to the fullest extent possible. In response to specific feedbacks, we conducted careful modification and clarification. We believe that this revised manuscript is stronger as changes made in response to the feedbacks and hope you agree with this. For your convenience, the reviewer’s comments are reproduced with our highlightened responses following the comments. To keep the revised manuscript clearly readable, we highlight our major revisions and additions in colored texts, instead of keeping track of all minor changes of words or deletions at the same time. Please refer to the revised manuscript as well as our responses to the reviewer reports for the details. We have tried to rectify the English language problem by giving it to an English expert and he had make corrections according to sentence structure, punctuation, grammar and contextual spelling. We hope that the manuscript has appropriate English style and terminologies for readers. Further comments are also incorporated.

Again, we wish to thank the great help from the reviewers as well as the kind assistance from the editor.

Reply to Reviewer 3：

Comment1:

I do not find in the article the answer of these questions: Why is this research important? Who will be interested in your research? What are the results of your study? 

Reply: Thank you very much for your careful reading. As, we have already brief regarding the structure of our “Narrative Review Article” but we have also add some text in the introduction section for the better understanding of readers by considering your raised concerns.

According to EMH, there is no room for excess returns but later on, different anomalies found and investors gain excess returns even in the existence of EMH. Shortly, the literature finds a shred of evidence that these anomalies are weak in magnitude or sometimes their presence was just a falsification when these studies replicated. Therefore, this narrative review article is an attempt to address this issue in order to combine historic literature from every possible dimension and try to make it an extensive study of available evidence for researchers who are interested in doing their research in the particular field. Besides, this narrative review not only explains the existing knowledge of the topic based on the published research but also an attempt to explain the current state of understanding on the topic.

Comment2:

The article seems to be a literature review but only old articles are mentioned without be emphasized the relevant and new articles published in this field.

Reply: Thank you very much for your valuable comments. We have incorporate some new evidences in the article and we have make tables of cited articles in each section for the better understanding of the reviewers (Here only one table is shown, Rest of the tables can be seen in the modified version of manuscript):

 CAPM face so many criticisms by scholars in finance, still it is most widely used asset pricing model in financial research(Rasheed et al. 2016).

(Ball et al. 2019)predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings.

In recent years, (Donangelo et al. 2019), and (Favilukis, Lin, and Zhao 2019) argue that labor leverage may play an important role in shaping the cross-sectional variation of equity returns.

Table 5. Selected work on Reasons behind Cross Sectional Excess returns

Comment 3: Also the critical approach is missing from this article.

Reply: As it is mentioned in the article that there is no space for excess returns in the presence of EMH but still we have evidences of excess returns. All the work of excess returns are actually criticism on the theory of EMH. In the later section, this narrative review also criticize the literature of “Excess Return” by referring the literature in section “Replication: The futuristic approach”. This section quoted all those literature findings that criticizes the existence of excess returns and give evidences by raising questions on the authenticity of existing literature of excess returns.

Comment 4:

I recommend to the authors to rewrite the paper after a deeper analyses of all the relevant literature in this field and related with all the five hypotheses mentioned in the lines 52-63 from the introduction part.

Reply: Thank you very much for your valuable comments. We have tried to improve the structure of paper by incorporating the comments of reviewers and it can be seen in the latest version of the article. We would also like to mention about the hypothesis given in the introduction section that these five hypothesis related to excess returns in the presence of EMH. Therefore, this narrative review article starts with the origination of EMH and mentions all-important references related to the theory, and then critique on the theory of EMH by quoting the evidences of excess returns. Later on, we have critique on the literature of excess returns by mentioning latest evidences of replication of past studies of Anomalies/Excess returns. This narrative review article raised question on the authenticity of Past literature of Anomaly returns based on connecting this whole literature. Hence, based on this logical sequence of prior literature, our study provides enough evidences of all mentioned hypothesis.

Reviewer 4 Report

Line 104 - References are omitted.

Figure 1 - This figure is presented but no comments regarding it are displayed.

Section 2.2 : it is not clear why the authors have decided to make this as an autonomous section.

Line 248: close the parenthesis in the title

Author Response

Dear Editor and Reviewer：

We are grateful for the opportunity to revise and resubmit this manuscript. We have tried to address the reviewer’s concerns to the fullest extent possible. In response to specific feedbacks, we conducted careful modification and clarification. We believe that this revised manuscript is stronger as changes made in response to the feedbacks and hope you agree with this. For your convenience, the reviewer’s comments are reproduced with our highlightened responses following the comments. To keep the revised manuscript clearly readable, we highlight our major revisions and additions in colored texts, instead of keeping track of all minor changes of words or deletions at the same time. Please refer to the revised manuscript as well as our responses to the reviewer reports for the details. We have tried to rectify the English language problem by giving it to an English expert and he had make corrections according to sentence structure, punctuation, grammar and contextual spelling. We hope that the manuscript has appropriate English style and terminologies for readers. Further comments are also incorporated.

Again, we wish to thank the great help from the reviewers as well as the kind assistance from the editor.

Reply to Reviewer 4：

Comment1: Line 104 - References are omitted.

Reply: Thankyou very much for your useful comment. We have cited the reference of Line 104 but in new edited version of article, it is in the Line 115:

Thus, after World War 2, studies on EMH increased significantly, but not all studies concluded in favour of the EMH hypothesis(G.Malkeil 1973).

Comment 2: Figure 1 - This figure is presented but no comments regarding it are displayed.

Reply: Thank you very much for your comment. Following detail is added in reference to the description of Figure 1:

The three versions of the efficient market hypothesis are varying degrees of the same basic theory.The strong form version of the efficient market hypothesis states that all information (both the information available to the public and any information not publicly known) is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market. The semi strong efficiency theory follows the belief that because all information that is public is used in the calculation of a stock's current price, investors cannot utilize either technical or fundamental analysis to gain higher returns in the market. The weak form suggests that today’s stock prices reflect all the data of past prices and that no form of technical analysis can be effectively utilized to aid investors in making trading decisions. Advocates for the weak form efficiency theory believe that if fundamental analysis is used, undervalued and overvalued stocks can be determined.

Comment 3: Section 2.2: it is not clear why the authors have decided to make this as an autonomous section.

Reply: Thank you very much for your comment. We have changed some parts of article by considering the comments of other reviewers and Section 2.2 is one of them. Now, the amended title of this section is as follows:

2.2. Modern Era of Efficient Market Hypothesis and it’s critics

Section 2.2 is following the flow of section 2.1 because in modern era, EMH is not only criticized but also challenge by many studies and these studies makes a room for excess returns under different anomalies. Therefore, this section creates criticism on EMH and starts a new discussion on existence of anomalies/excess returns.

Comment 4: Line 248: close the parenthesis in the title.

Reply: Thank you very much for your comment. It was a typo mistake and we have make correction of this comment and changing can be seen in line 265 of amended version.

Round 2

Reviewer 3 Report

The article is more clearly presented now. Below are some recommendations necessary to improve the quality of this paper:

·       In the introduction part, the authors must emphasize how this study contribute to knowledge in the field and also to the prior literature. It is mandatory to present a summary of findings in the introduction part. I do not find mentioned here: who would be interested in this study?

·       I do not find anything in the chapter 2.2. to sustain the second hypothesis: how digitalisation affects the market. The author should develop this subject.

·       I recommend to include in the section 3.2 an innovative research that proposes a new valuation model to measure the book value of equity which affects the stock valuation: “Measuring the company’s real performance by physical capital maintenance, Economic Computation and Economic Cybernetics Studies and Research, 51(1): 37-57.

·       In chapter 4, you should include an important anomaly demonstrated by a recent paper for the LSE: stock prices are influenced by investments in fixed assets only for the loss companies : https://doi.org/10.3390/en11020448

·       In the conclusion part: summarize findings and implications of your research, discuss limitations, and provide any caveats.

Author Response

Dear Editor and Reviewer：

We are grateful for the opportunity to revise and resubmit this manuscript. We have tried to address the reviewer’s concerns to the fullest extent possible. In response to specific feedbacks, we conducted careful modification and clarification. We believe that this revised manuscript is stronger as changes made in response to the feedbacks and hope you agree with this. For your convenience, the reviewer’s comments are reproduced with our highlightened responses following the comments. To keep the revised manuscript clearly readable, we highlight our major revisions and additions in colored texts, instead of keeping track of all minor changes of words or deletions at the same time. Please refer to the revised manuscript as well as our responses to the reviewer reports for the details. Further comments are also incorporated.

Again, we wish to thank the great help from the reviewers as well as the kind assistance from the editor.

Reply to Reviewer 3：

Comment1:

  In the introduction part, the authors must emphasize how this study contribute to knowledge in the field and also to the prior literature. It is mandatory to present a summary of findings in the introduction part. I do not find mentioned here: who would be interested in this study? 

Reply: Thank you very much for your careful reading. We have tried to incorporate your suggestions but as far as your suggestion regarding the summary of findings in introduction is concerned, this narrative review paper is purely based on existing literature and it had no empirical findings. This narrative review paper consists of theoretical review of Anomaly as well as EMH literature and introduction part depicts the essence of whole article just like the summary of complete article. We have tried to make it more clear to the readers by editing and rearranging the introduction part in revised manuscript. We have also try to incorporate your comments by adding following section in introduction part in response to comment 1:

Existing literature do not have much focus on the critique of existing anomalies as there are many anomalies found just a falsification. Hence, this review article make an addition in the historical literature by raising question on the authentication of existing anomalies based on newly published evidences. While this study will not only help academicians and practitioners to find extensive anomaly literature for their future research but will also help investors in many ways. Like, the study will help investors to calculate expected returns on stocks by using different valuation parameters. Secondly, based on varying anomaly characteristics, this research will assist investors to create profitable portfolios in order to gain excess returns. Thirdly, this study will also be valuable for academicians, practitioners and investors to authenticate the true existence of past anomalies instead of relying on existing published literature.

Comment2:

I do not find anything in the chapter 2.2. to sustain the second hypothesis: how digitalisation affects the market. The author should develop this subject

Reply: Thank you very much for your valuable comments. We have tried to incorporate some new evidences related to digitalization effect by adding the following text:

 With technological advancements facilitating vibrant creation, sharing, and collaboration among Web users, the impact of digital media on stock markets has been increasingly prominent. Many studies have investigated the effect of digital media on stock movements (Bollen, Mao, and Zeng 2011). (Liu and Zhang 2012) analyzed the effectiveness of the wording in clarification announcements. They found that detailed clarification information helps mitigate the impact of rumours, and the stock price tends to return to normal levels after 30 trading days. More notably, web digitalized platforms as a governance strategy of regulating authorities have been implemented for a long time. Therefore, richer information releases by digital platforms increase market transparency (Wang et al. 2019).

Comment 3:  I recommend to include in the section 3.2 an innovative research that proposes a new valuation model to measure the book value of equity which affects the stock valuation: “Measuring the company’s real performance by physical capital maintenance, Economic Computation and Economic Cybernetics Studies and Research, 51(1): 37-57

Reply: Thank you very much for your valuable comment. We have cited the following reference in section 3.2:

(Jianu, Jianu, and Țurlea 2017)create a model based on physical capital maintenance that measures the real performance of the company in order to obtain better information for investors.

Comment 4: In chapter 4, you should include an important anomaly demonstrated by a recent paper for the LSE: stock prices are influenced by investments in fixed assets only for the loss companies : https://doi.org/10.3390/en11020448

Reply: Thank you very much for your valuable comment. We have cited the following reference in chapter 4:

By using the Ohlson share price model for a sample of 51 listed companies on the London Stock Exchange proves that investments in long-term assets influence the share price in the case of companies which record losses (Jianu and Jianu 2018).

Comment 5: In the conclusion part: summarize findings and implications of your research, discuss limitations, and provide any caveats.

Reply: Thank you very much for your valuable comments. We have tried to incorporate your comment by adding following text in conclusion and limitations section.

In modern times, published literature on anomaly returns has gain much attention of academicians and researchers. Therefore, In the light of anomaly literature, markets are no more efficient and investors can predict and gain excess returns by using the available room of these anomalies. Shortly, based on replication of existing anomaly literature, a new dimension emerged when many past studies found falsified and a new discussion starts on the current state of markets and reality of these anomalies.

Moreover, researchers must admit that the existing evidence regarding anomalies is not a constitutional proof and the established paradigms are wrong. The issue of data snooping, found in many types of research, gives an alarming indication regarding the reliability of these studies. Data snooping affects all aspects of return procedures, averages and variations with other anomalies and factors. Future research can gain advantage from the new historical sample to take more insights into asset prices.

The limitations of the study are as follow: A lot of work in the literature has been analytical, case study, and simulation-based. We identified several factors from the extant literature; however, more empirical studies will be needed for validation. The findings of this article are based on a review of more than 90 papers but still it is possible that some important papers might not be included. As it is a qualitative analysis of the documents on the focused themes, personal biases might have occurred.