BTL 787 - Efficient Market Hypothesis (EMH)

 

The Banking Tutor’s Lessons

BTL 787                                                            24-05-2025

Efficient Market Hypothesis (EMH) 

The Efficient Market Hypothesis (EMH) posits that financial markets are "informationally efficient," meaning that asset prices reflect all available information at any given time. 

The EMH is categorised into three forms: weak, semi-strong, and strong. 

The weak form suggests that past price movements are reflected in current stock prices, while the semi-strong form asserts that all publicly available information is accounted for in stock prices. The strong form includes all information, both public and private. 

The theory suggests that any new information, whether it is economic data, company earnings, or geopolitical events, is quickly incorporated into stock prices. 

The EMH theory divides the market efficiency into three distinct forms: weak, semi-strong, and strong. 

In the weak form, historical price movements and volume data cannot be used to predict future price changes, as all past information is already reflected in current prices. 

The semi-strong form asserts that stock prices adjust rapidly to publicly available information, making fundamental analysis ineffective in generating excess returns.

The strong form goes a step further by claiming that even insider information cannot provide an advantage, as all information is already reflected in stock prices. 

The implications of EMH are profound for investors. If markets are efficient, then active investment strategies—such as stock picking or market timing—are unlikely to outperform a passive investment approach over the long term. 

This understanding leads many investors to adopt passive index funds or diversified portfolios, aligning their strategies with the EMH theory. 

Ultimately, the theory emphasizes the importance of accepting market prices as the best indicators of value, highlighting the challenges faced by those attempting to beat the market consistently. 

Sekhar Pariti

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