Efficient Market Hypothesis

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Recommended: Empirical implications of efficient market hypothesis

For a market to be considered efficient it means that at any given time market prices will fully reflect all available information. If this holds true, it means that it would be impossible for investors to beat the market, as securities would always trade at their fair value making fundamental and technical analysis ineffective. Investors would only be able to obtain normal rates of return in an efficient market. This idea is captured in the Efficient Market Hypothesis (EMH) that was thought up by Eugene Farma in his Ph.D. dissertation in the 1960s. As part of the EMH there are three possible levels of efficiency. These include weak, semi-strong, and strong form. In the weak form of market efficiency it is assumed that all past prices and past public information of a security are reflected in the securities current price. In the semi-strong form of market efficiency it is assumed that all public information about a security is reflected in it’s current price and the current price instantly adjusts to new information. Lastly, there is strong form efficiency where it is assumed that all information, public and private, is instantly reflected in the price of a security. It is very difficult to conclude that the U.S. market falls perfectly into one of these three categories because there are various examples of the market acting, or not acting, like each of the forms. One of the best examples to understand the strong form market efficiency is to look at insider trading. Insiders in a company have access to private information and the ability to trade on this information but if strong form efficiency holds true then these insiders should not be able to profit off this knowledge. The Securities and Exchange Commission, along with vario... ... middle of paper ... ... low accruals and positive earnings surprises and shorting stocks with high accruals and negative surprises. All of this information is available to the public so the fact that by using this information an investor can achieve returns greater than the market makes me question the idea of semi-strong efficiency. Even though I question semi-strong efficiency I do believe that the market is greater than weak form efficiency because in most cases the market does react immediately to newly released public information. I also believe that the quality of earnings and market efficiency are interrelated. For a market to be efficient the inputs used must be of a high quality. This can also be thought of as “garbage in, garbage out” because if low quality earnings are used as the inputs for market pricing then the output and the efficiency of the market will be severely hurt.

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