Efficient Market Hypothesis

Efficient Market Hypothesis (EMH) is a financial theory that asserts that Asset prices reflect all available information at any given time. This means that Stocks and other Securities are always traded at their fair value, making it impossible for investors to consistently achieve higher Returns than the average market return on a risk-adjusted basis. The hypothesis is divided into three forms:

• Weak Form: Asserts that past prices and trading volumes do not provide any advantage in predicting future price movements. For example, technical analysis is deemed ineffective since all historical data is already reflected in current prices.
• Semi-Strong Form: Claims that all publicly available information is already incorporated into Stock prices. This implies that fundamental analysis cannot provide an advantage. For instance, if a company announces better-than-expected earnings, the Stock price will adjust almost immediately, leaving no opportunity for Arbitrage.
• Strong Form: Suggests that all information, both public and private (insider information), is reflected in Stock prices. Therefore, even Insider Trading cannot yield superior Returns. An example would be if an insider knows about an upcoming merger, the Stock price would already reflect this knowledge due to the market’s efficiency.

Critics of EMH point to market anomalies, bubbles, and crashes as evidence that markets can be inefficient. Notable cases include the dot-com bubble in the late 1990s and the housing market crash in 2008, where Asset prices deviated significantly from their Intrinsic Values.