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Efficient Market Hypothesis 
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

The efficient market hypothesis of movements of stock prices in its weak variant stands for the proposition that successive stock prices are mostly unrelated and that prices tend to move in a random manner.  The randomness of stock prices is reported to be confirmed by analysis of successive price changes, indicating low serial correlation coefficients, and by simulated charting of random numbers, indicating patterns of price movements similar to actual price movement patterns.  On this basis, proponents of the random walk hypothesis dismiss the usefulness of TECHNICAL, ANALYSIS, an approach for predicting stock prices based on the price patterns developed by prior price data.

A second variant of the efficient market hypothesis stands for the proposition that:  (1) there are many participants in an efficient market; (2) such participants have access to all relevant information affecting stock prices; and (3) such participants compete freely and equally for the stocks, causing, because of such competition and the full information available to the participants, full reflection of the worth of stocks in their prevailing prices.  As new information randomly develops and is acted upon and reflected in prices, stock prices in turn behave randomly.

A third variant of the efficient market hypothesis stands for the proposition that prevailing stock prices fully reflect and discount not only publicly available information but also private and expert analyses and information, such as that made available to institutional investors in consideration of routing commission business to particular brokerage firms, and "research boutiques."  Since performance of institutional investors such as investment companies is found to be not much different from results of noninstitutional portfolios and from randomly selected portfolios, it is concluded again that prevailing stock prices in responding promptly to randomly developed information, whether publicly or privately available through expert analyses, behave randomly, and that professional money managers do not achieve consistently superior performance because of superior access to superior information.

All three variants of the efficient market hypothesis challenge the validity of fundamentals analysis and technical analysis, and in turn are challenged by adherents of the fundamental and technical approaches.

The efficient markets theory, or what is also called "the new investment technology," is the idea that security markets are efficient and that investment rewards are related to risk.

According to this theory, a market is said to be efficient if it functions in such a way that transaction costs to buyers and sellers in the market are relatively low and information on new developments is quickly disseminated to all parties.  Market prices will reflect such new information.

Advocates of the efficient markets theory stress that risk has its rewards, and, on average, investors obtain greater returns for incurring greater risks.  They emphasize that if investments are always efficiently priced in the market, the only way for the average investor to obtain returns above the average for the market is to take on more risk.

Over the past several decades, numerous academic studies have examined the question of the relative efficiency of security markets. Most of these studies have found that the money and capital markets are weak-form efficient, and some have reported semistrong-form efficiency.  Markets dot not appear to be strong-form efficient, so possessors of inside information have a definite advantage over the average investor.

The efficient markets theory suggests that even professional money managers, unless they have access to inside information, cannot consistently obtain returns above the average for the market as a whole unless they are willing to take on an above average level of risk.  Some of the most convincing evidence in support of the theory has been amassed by studies that show that the great majority of professional investment managers do not consistently outperform the market averages.  Indeed, Burton Malkiel, one of the foremost proponents of the efficient markets theory, claims that "no scientific evidence has yet been assembled to indicate that the investment performance of professionally managed portfolios as a group has been any better than that of randomly selected portfolios."


GREEN, G.H.  "The Effect of Inter-Regional Efficiency on Appraising Single Family Homes."  The Real Estate Appraiser and Analysts, Winter, 1988.

IPPOLIYO, T.S.  "Efficiency With Costly Information:  A Study of Mutual Fund Performance, 1965-1984."  The Quarterly Journal of Economics, February, 1989.

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