Efficient market hypothesis
The efficient market hypothesis that markets operate efficiently. In other words, that assets are fairly priced by the market mechanism to incorporate available information.
There are three forms of potential efficiency: the weak form, the semi-strong form and the strong form.
- The weak form states that past prices are no guide to future prices, so charting techniques cannot be used to make excess returns.
- The semi-strong form states that prices react to public information so that any form of analysis using publicly available information cannot be successful in consistently generating excess returns.
- The strong form states that even insider information cannot generate consistent excess returns.
Important implications of the efficient market hypothesis for financial managers include:
- Keeping the financial markets well-informed.
- Taking market price movements seriously.
- Not attempting to 'fine tune' the timing of security issues.
Also known as the Efficient markets hypothesis.
In practice, extreme market outturns occur more commonly than predicted by simple efficient markets theory.
As a consequence, the simplistic application of efficient markets theory to risk analysis will systematically:
- Overstate market stability, and
- Understate related market risks.