[Finance] Efficient Markets Hypothesis (EMH)

Assumptions

  • Large number of investors operating in the market for profit
  • New information arrives randomly
  • Prices adjust quickly
  • Prices reflect all available information

Three forms of the EMH

1) The weak form of the EMH
  • Says that future prices cannot be predicted by analysis of previous (historical) prices
  • The idea here is that the current price reflects all the information we might know - so just by looking at these historical prices you can’t predict what is going to happen next
  • It is silent on fundamental or insider information
  • This does leave room for Fundamental Analysis
2) The semi-strong version of the EMH
  • Suggests that prices adjust immediately to new public information
  • So if semi-strong is correct that would seem to prohibit even fundamental analysis because the prices adjust quickly
3) The Strong version of EMH
  • Says we can’t even make money on insider information - it can’t be leveraged!
  • Prices reflect all information public and private

  • If the strong version of the EMH is true, it is essentially impossible to make money by holding a portfolio other than the market portfolio


    EMH
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