8.5 Efficient market hypothesis

Question 1

What is the efficient market hypothesis, developed by Eugene Fama in the 1960s?

Answer 1

The hypothesis states that it is impossible to “beat the market” if the market is efficient, since market price will always reflect the available information and stocks are therefore always traded at fair values.

Question 2

According to the EMH, the market price of a share reflects its unbiased intrinsic value. What is meant by this?

Answer 2

The market price should reflect the inherent worth of the share, determined through fundamental analysis without taking into account the market value of the share.

Question 3

Fama identified three levels of market efficiency as part of the EMH. What were these?

Answer 3

1 Weak form - market price is reflective of historical information
2 Semi-strong - market price reflects not just historical data but all currently available information
3 Strong form - market price reflect all relevant available information, so even insiders are unable to make abnormal returns.