What is the Efficient Market Hypothesis (EMH)?
EMH states that asset prices fully and quickly reflect all available information.
What does “efficient” mean in EMH?
Prices adjust rapidly and correctly to new information.
What is the core idea behind EMH?
It is impossible to consistently earn abnormal returns using available information.
What are the key assumptions underlying EMH?
- Rationality
- Information
- Arbitrage
Do all investors need to be rational for markets to be efficient?
No. As long as rational investors dominate and arbitrage exists, markets can still be efficient.
Why is arbitrage important for EMH?
Arbitrage eliminates mispricing by exploiting price deviations.
What is the theoretical foundation of EMH?
EMH is grounded in rational expectations and competitive financial markets.
How does competition support EMH?
Competition among investors ensures information is rapidly incorporated into prices.
What role do expectations play in EMH?
Prices reflect investors’ expectations about future cash flows based on available information.
What distinguishes the different forms of EMH?
The type of information assumed to be reflected in prices.
What is weak-form efficiency?
Prices reflect all information contained in past prices and volume
What is semi-strong form efficiency?
Prices reflect all publicly available information.
What is strong-form efficiency?
Prices reflect all information, both public and private, including inside information.
What is private information in EMH?
Information that is not publicly available to all investors.
Why is private information important for strong-form EMH?
Strong-form EMH implies even private information cannot be used to earn abnormal returns.
What are the main implications of EMH for investors?
Active portfolio management cannot consistently outperform the market.
Does EMH assume insider trading is impossible?
Strong-form EMH implies insiders cannot consistently profit, though this is debated empirically.
What does EMH imply about technical and fundamental analysis?
They should not systematically generate abnormal returns in efficient markets.
What does EMH imply for portfolio choice?
Passive investing and diversification are optimal strategies.
Can bubbles exist under EMH?
EMH suggests persistent bubbles are unlikely, but temporary mispricing may occur.
How are bubbles explained by EMH supporters?
As rational responses to changing information or risk.
Why do bubbles challenge EMH?
They suggest prices may deviate significantly from fundamental values.
What is the random walk hypothesis?
Price changes are unpredictable and follow no systematic pattern.
How is random walk related to EMH?
If markets are efficient, price changes should be random.
