Efficient Market Hypothesis

Definition

The Efficient Market Hypothesis (EMH) is a financial theory that suggests in an efficient market, all available information is immediately reflected in the prices of securities. Therefore, investors cannot achieve excess returns through market analysis and prediction. According to this hypothesis, market prices always fully reflect all relevant information, making it impossible for any investment strategy to consistently outperform the market.

Origin

The concept of the Efficient Market Hypothesis was first introduced by Eugene Fama in the 1960s. He elaborated on this theory in his 1965 paper and further developed its three forms—weak, semi-strong, and strong—in 1970. The formation of this theory marked a significant milestone in financial market research.

Categories and Features

The Efficient Market Hypothesis is mainly divided into three types:
1. Weak Form EMH: Assumes all past prices and volume information are reflected in current prices, making technical analysis ineffective for achieving excess returns.
2. Semi-Strong Form EMH: Assumes all publicly available financial statements, news, and public information are reflected in current prices, rendering fundamental analysis ineffective for excess returns.
3. Strong Form EMH: Assumes all information, including insider information, is reflected in current prices, making any form of analysis ineffective for achieving excess returns.
The main features of EMH include rapid information reflection, random price changes, and market efficiency.

Case Studies

Case 1: During the 2008 financial crisis, many investors attempted to predict the market bottom through trend analysis. However, according to EMH, market prices already reflected all known information, and most investors failed to accurately predict the timing of the market rebound.
Case 2: After the 2016 Brexit referendum, the market quickly adjusted to reflect new political and economic information. Although some investors tried to profit from this event, the rapid adjustment of market prices meant that most strategies did not achieve the expected excess returns.

Common Issues

Investors often misunderstand EMH, thinking it implies the market is always correct. In reality, the hypothesis only suggests that market prices quickly reflect all available information, not that they are always reasonable. Additionally, investors may overlook the assumptions of market efficiency, such as the speed of information dissemination and the rationality of market participants.