Business, Legal & Accounting Glossary
Share prices in a stock market react immediately to the announcement of new information.
The Efficient Market Hypothesis (also known as EMH) is an investment theory whereby share prices reflect all information and consistent alpha generation is impossible.
According to the efficient market hypothesis, market participants possess an equal amount of information on assets traded in the market. It was Professor Eugen Fama of the University of Chicago Graduate School of Business, who developed the efficient market hypothesis. The efficient market hypothesis implies that at a given point in time, prices of traded assets reflect its true value. In finance, framing definite laws is difficult. Hence opinion is divided regarding the validity of the efficient market hypothesis.
One criticism levied against the efficient market hypothesis is an incorrect assumption that investors perceive information about traded assets in a similar manner. Proof against this assumption lies in dissimilar returns earned by market participants who invest an equal amount of money. This is contrary to the efficient market hypothesis, since, by that theory, all investors possess equal information about traded assets and hence should derive equal returns. Other forms of efficient market hypothesis include weak-form efficiency, semi-strong form efficiency, and strong-form efficiency.
According to weak-form efficiency, higher returns cannot be earned from strategies based upon old share prices. Earning higher returns is also not possible by the use of technical analysis, but fundamental analysis may help in that regard.
According to semi-strong-form efficiency, share price changes reflect any information that has become public. It also states that both fundamental and technical analysis techniques do not guarantee higher returns.
According to strong-form efficiency, all information about traded assets gets reflected on share prices. This includes private as well as public information. A strong-form hypothesis is impossible when private barriers exist that prevent private information from being made public.
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This glossary post was last updated: 29th March, 2020 | 8 Views.