10.2: The Efficient Market Hypothesis (EMH) Flashcards
What is the Efficient Market Hypothesis (EMH)?
The Efficient Market Hypothesis (EMH) is the theory that markets are efficient, meaning prices accurately reflect all available information at any given time.
It suggests that securities are correctly priced, based on their intrinsic value, due to the market’s rapid incorporation of all relevant information.
Define the weak form EMH.
The weak form EMH posits that security prices fully reflect all market data, including past prices and volume.
As a result, technical analysis based on historical price movements is of no value in predicting future prices.
What is the semi-strong form EMH?
The semi-strong form EMH asserts that all publicly known and available information is reflected in security prices.
This includes financial statements, news, and other publicly accessible data, rendering fundamental analysis ineffective for finding undervalued stocks.
Explain the strong form EMH.
The strong form EMH claims that stock prices reflect all information, both public and private.
No investor can achieve superior gains using insider information since all data is already incorporated into current stock prices.
How does the EMH relate to different levels of market efficiency?
The EMH suggests varying degrees of efficiency in how prices incorporate information.
The weak form focuses on historical data, the semi-strong form includes all publicly available information, and the strong form considers all information, even private, in reflecting accurate stock prices.
Why is the strong form EMH considered stringent?
The strong form EMH is considered stringent because it implies that even insider information is already reflected in stock prices, making it impossible for any investor to consistently achieve abnormal returns through any form of analysis or information advantage.
Explain the efficient market hypothesis (EMH).
The Efficient Market Hypothesis (EMH) is the proposition that financial markets are efficient in reflecting information about securities, suggesting that stocks always trade at their fair value, making it impossible to consistently achieve higher returns without taking on more risk.
Describe the various forms of the EMH.
The EMH is categorized into three forms:
Weak Form: Prices reflect all past trading information, implying technical analysis is ineffective.
Semi-Strong Form: Prices incorporate all publicly available information, making fundamental analysis ineffective for gaining an advantage.
Strong Form: Prices reflect all information, both public and private, negating the advantage of insider information.
