American Finance Association
Efficient Capital Markets: II
Author(s): Eugene F. Fama
Source: The Journal of Finance, Vol. 46, No. 5 (Dec., 1991), pp. 1575-1617 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2328565
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* VOL. XLVI, NO. 5 * DECEMBER
Efficient Capital Markets: II
EUGENE F. FAMA*
SEQUELSARE RARELY good as the originals,
so I approach this review of the
market efflciency literature with trepidation. The task is thornier than it was 20 years ago, when work on efficiency was rather new. The literature is now so large that a full review is impossible, and is not attempted here. Instead, I discuss the work that I find most interesting, and I offer my views on what we have learned from the research on market efficiency.
I. The Theme
I take the market efficiency hypothesis to be the simple statement that security prices fully reflect all available information. A precondition for this strong version of the hypothesis is that information and trading costs, the costs of getting prices to reflect information, are always 0 (Grossman and Stiglitz (1980)). A weaker and economically more sensible version of the efficiency hypothesis says that prices reflect information to the point where the marginal benefits of acting on information (the profits to be made) do not exceed the marginal costs (Jensen (1978)).
Since there are surely positive information and trading costs, the extreme version of the market efficiency hypothesis is surely false. Its advantage, however, is that it is a clean benchmark that allows me to sidestep the messy problem of deciding what are reasonable information and trading costs. I can focus instead on the more interesting task of laying out the evidence on the adjustment of prices to various kinds of information. Each reader is then free to judge the scenarios where market efficiency is a good approximation (that is, deviations from the extreme version of the efficiency hypothesis are within information and trading costs) and those where some other model is a better simplifying view of the world.
Ambiguity about information and trading costs is not, however, the main obstacle to inferences about market efficiency. The joint-hypothesis problem is more serious. Thus, market efficiency per se is not testable. It must be * Graduate School of Business, University of Chicago. The comments of Fischer Black, David Booth, Michael Bradley, Michael Brennan, Stephen Buser, John Campbell, Nai-fu Chen, John Cochrane, George Constantinides, Wayne Ferson, Kenneth French, Campbell Harvey, Richard...
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