Efficient Market Hypothesis

Knowledge Center

• About
• Home
• Dictionary
• Encyclopedia
• Question?
• Views

• Register
• Log in
• Help

• Change & Organization
• Communication & Skills
• Decision-making & Valuation
• Ethics & Responsibility
• Finance & Investing
• HRM
• Knowledge & Intangibles
• Leadership
• Marketing
• Program & Project
• Strategy
• Supply Chain & Quality

Description of the Efficient Market Hypothesis. Explanation.

Definition Efficient Market Hypothesis. Description

Efficient Market Hypothesis (EMH) states stock market prices reflect the knowledge and expectations of all investors at any given point in time.

In other words, financial markets are considered "informationally efficient": because all information is publicly available at the time an investment is made.

Because of this, one cannot consistently achieve Abnormal Returns in excess of average market returns on a risk-adjusted basis.

Investors who follow this theory consider it futile to forecast stock price movements using financial statements or to search for undervalued or overvalued stocks, as any new development is quickly reflected in an organization's stock price.

EMH theory does not entirely preclude the use of financial statements for investment decisions, as financial information about an organization can still have value for predicting the degree to which the stock price moves up or down with market wide stock price movements, even if markets are efficient.

Basis of Portfolio Theory and CAPM

The Efficient Market Hypothesis is the basis of 2 major capital asset pricing models: The Portfolio Theory by Harry Markowitz and the Capital Asset Pricing Model by William Sharpe.

Weak EMH, Semi-strong EMH, and Strong EMH

In fact there are 3 versions of the hypothesis: "weak", "semi-strong", and "strong".

• The Weak Efficient Market Hypothesis argues that future share prices cannot be predicted by analyzing prices from the past. So prices of traded assets (e.g., stocks, Bonds, Index Funds, Mutual Funds, etc.) already reflect all past publicly available information.
• The Semi-strong Efficient Market Hypothesis claims 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. So prices of traded assets reflect all publicly available information and prices instantly change to reflect new public information.
• The Strong Efficient Market Hypothesis additionally claims that share prices reflect all information, public and private, and no one can earn excess returns. So prices of traded assets instantly reflect even hidden or "insider" information.

Critics of Efficient Market Hypothesis

The EMH disregards the field of Behavioral Finance and phenomena such as Cognitive Bias, Bounded Rationality and Groupthink / Investor Sentiment. Speculative bubbles are obviously also contradicting EMH theory. According to some theorists the widespread belief in EMH was actually the main reason why the economic crisis of 2007 occurred.

Compare also with: Systemic Risk  |  Capital Assets Pricing Model  |  Fundamental Analysis  |  Technical Analysis  |  Quantitative Investment Analysis  |  Buy-Side Analyst  |  Sell-Side Analyst 

Efficient Market Hypothesis Special Interest Group Special Interest Group (10 members)

Efficient Market Hypothesis Forum   In the forum section you will find recent discussions within this knowledge area.   Quotes on the Efficiency of Markets. Quotations (0 reactions) Hi, do you know of a remarkable, humorous quote by a famous ...

Best Practices - Efficient Market Hypothesis In the best practices section you will find the best forum discussions within this knowledge area.

Expert Tips - Efficient Market Hypothesis In the expert tips section you will find advices from experts within this knowledge area.

Resources - Efficient Market Hypothesis In the Resources section you will find powerpoint presentations, micro-learning videos, articles, news items, etc. within this knowledge area. Introduction to Capital Market Efficiency: Portfolio Theory and CAPM CAPM, Portfolio Theory, Efficient Markets Hypothesis, Risk and Expected Return, Investing, Financial Asset Valuation...   Efficient Markets and Behavioral Financial Decision Making Behavioral Finance, Rational Decision-making, CAPM...   Interview Sharpe: Background CAPM Understanding Two Basic Elements behind CAPM...   Value Premium and CAPM Value Premium Analysis...   Giving Financial Advice on Dealing with Uncertainty Financial Services, Asset Management, Financial Investing...   Interview W. Blake: Golden Rules of Investing Advanced Implementation of Investing...     News about Efficient Market Hypothesis         Videos about Efficient Market Hypothesis         Presentations about Efficient Market Hypothesis         Books about Efficient Market Hypothesis         More about Efficient Market Hypothesis

Return to Management Hub: Decision-making & Valuation  |  Finance & Investing

More on Management  |  Return to Management Dictionary  | 

This ends our Efficient Market Hypothesis summary and forum.