The Efficient Market Hypothesis

The EMH asserts that financial markets are informationally efficient with different implications in weak, semi-strong, and strong form.

Learning Objective

  • Differentiate between the different versions of the Efficient Market Hypothesis

Key Points

    • In weak-form efficiency, future prices cannot be predicted by analyzing prices from the past.
    • In semi-strong-form efficiency, it is implied that share prices adjust to publicly available new information very rapidly and in an unbiased fashion, such that no excess returns can be earned by trading on that information.
    • In strong-form efficiency, share prices reflect all information, public and private, and no one can earn excess returns.

Terms

  • technical analysis

    A stock or commodity market analysis technique which examines only market action, such as prices, trading volume, and open interest.

  • fundamental analysis

    An analysis of a business with the goal of financial projections in terms of income statement, financial statements and health, management and competitive advantages, and competitors and markets.

  • insider trading
    Buying or selling securities of a publicly held company by a person who has privileged access to information concerning the company's financial condition or plans.

The efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". In consequence of this, 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 additionally claims that prices instantly reflect even hidden or "insider" information.