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Market Efficiency

Behavior of an Efficient Market

Efficient-market hypothesis (EMH) asserts that financial markets are informationally efficient and should therefore move unpredictably.

Learning Objective

  • Describe what an efficient market looks like

Key Points

    • The efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". As a result, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.
    • Historically, there was a very close link between EMH and the random-walk model and then the Martingale model. The random character of stock market prices was first modelled by Jules Regnault, a French broker, in 1863.
    • The definitions for three forms of financial market efficiency: weak, semi-strong, and strong.

Term

  • Martingale model

    In probability theory, a martingale is a model of a fair game where knowledge of past events will never help to predict future winnings.

In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". As a result, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made.

There are three major versions of the hypothesis: "weak," "semi-strong," and "strong". The weak-form EMH claims that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. The semi-strong-form EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information. The strong-form EMH also claims that prices instantly reflect even hidden or "insider" information. Critics have blamed the belief in rational markets for much of the late-2000's financial crisis. In response, proponents of the hypothesis have stated that market efficiency does not mean having no uncertainty about the future. Market efficiency is a simplification of the world which may not always hold true. The market is practically efficient for investment purposes for most individuals.


Source: Boundless, http://kolibri.teacherinabox.org.au/modules/en-boundless/www.boundless.com/finance/textbooks/boundless-finance-textbook/security-market-efficiency-and-returns-9/market-efficiency-85/behavior-of-an-efficient-market-364-1030/index.html
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