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What is the Efficient Market Hypothesis?Efficient Market Hypothesis (EMH) states stock market prices reflect the knowledge and expectations of all investors at any given point in time. In other words, financial markets are considered "informationally efficient": because all information is publicly available at the time an investment is made. Because of this, one cannot consistently achieve Abnormal Returns in excess of average market returns on a risk-adjusted basis. Investors who follow this theory consider it futile to forecast stock price movements using financial statements or to search for undervalued or overvalued stocks, as any new development is quickly reflected in an organization's stock price. EMH theory does not entirely preclude the use of financial statements for investment decisions, as financial information about an organization can still have value for predicting the degree to which the stock price moves up or down with market wide stock price movements, even if markets are efficient. Basis of Portfolio Theory and CAPMThe Efficient Market Hypothesis is the basis of 2 major capital asset pricing models: The Portfolio Theory by Harry Markowitz and the Capital Asset Pricing Model by William Sharpe. Weak EMH, Semi-strong EMH, and Strong EMHIn fact there are 3 versions of the hypothesis: "weak", "semi-strong", and "strong".
Critics of Efficient Market HypothesisThe EMH disregards the field of Behavioral Finance and phenomena such as Cognitive Bias, Bounded Rationality and Groupthink / Investor Sentiment. Speculative bubbles are obviously also contradicting EMH theory. According to some theorists the widespread belief in EMH was actually the main reason why the economic crisis of 2007 occurred. Compare also with:
Systemic Risk |
Capital Assets Pricing Model |
Fundamental Analysis
| Technical Analysis | Quantitative Investment
Analysis | Buy-Side Analyst
| Sell-Side Analyst
|
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Return to Management Hub: Decision-making & Valuation | Finance & Investing More on Management | Return to Management Dictionary |
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