The Efficient Markets Hypothesis

Topics: Stock market, Efficient-market hypothesis, Fundamental analysis Pages: 2 (486 words) Published: July 23, 2013
The Efficient Markets Hypothesis

The theory of Efficient Markets Hypothesis (EMH) asserts that (1) stocks are always in equilibrium and (2) it is impossible for an investor to “beat the market” and consistently earn a higher rate of return than is justified by the stock’s risk. Those who believe in the EMH note that there are 100,000 or so fulltime, highly trained, professional analysts and traders operating in the market, while there are fewer than 3,000 major stocks. Therefore, if each analyst followed 30 stocks (which is about right, as analysts tend to specialize in a specific industry), there would on average be 1,000 analysts following each stock.

The forms of EMH are:

Weak-Form Efficiency
Technical analysts believe that past trends or patterns in stock prices can be used to predict future stock prices. In contrast, those who believe in the weak form of the EMH argue that all information contained in past price movements is fully reflected in current market prices. If the weak form were true, then information about recent trends in stock prices would be of no use in selecting stocks—the fact that a stock has risen for the past three days, for example, would give us no useful clues as to what it will do today or tomorrow. Those who believe that weak-form efficiency exists also believe that technical analysts, also known as “chartists,” are wasting their time.

Semi strong-Form Efficiency
The semi-strong form of the EMH states that current market prices reflect all publicly available information. Therefore, if semi-strong-form efficiency exists, it would do no good to pore over annual reports or other published data because market prices would have adjusted to any good or bad news contained in such reports back when the news came out. With semi-strong-form efficiency, investors should expect to earn the returns predicted by the SML, but they should not expect to do any better or worse other than by chance. Another implication of...
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