Key Concepts And Explanations Of The Efficient Market Hypothesis

915 WordsNov 9, 20164 Pages
Key Concepts and Explanations of the Efficient Market Hypothesis Overview Efficient Market Hypothesis (EMH) is a theory that states that it is impossible to beat the market due to the following reasons: • Assumption that markets are efficient • Investors make rational decisions • Market participants are sophisticated • Investors act quickly on information as it becomes available Since prices reflect all information there are no bargain prices. In efficient markets, prices become unpredictable and there is no investment pattern. Therefore, those who only support the EMH do not believe behavioural finance is necessary. Eugene Fama, known as “the father of finance”, has been recognized for his many contributions to the finance and economic world. Fama proposed the three types of efficiency: weak, semi-strong and strong. This concept regarding efficiency is still being used today. The weak form of efficiency assumes that all past market trading information is reflected in stock price. The semi-strong form states that all publicly available information regarding the prospects of a firm is reflected in the price. Lastly, strong form suggests that all information relevant to the firm, including insider information, is reflected in stock price. Justification of the Efficient Market Hypothesis EMH is a commonly used and is known as the foundation of financial theory. Those in support of this also tend to focus on the random-walk hypothesis. If the market is efficient then
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