Efficient Market Hypothesis Flashcards
Describe weak form EMH
if the weak version of this theory were to hold true, information available to everyone and therefore already built into stock prices would be all past price and trading information. This being the case, no outperformance would be possible from analysis of this information. The accuracy of this assumption seems to be backed by evidence with a number of studies supporting its contention.
This kind of readily accessible information is there even for individual investors so it would be unreasonable to expect
one person to be able to achieve outperformance by analysing it – many other people will have already done so
and this will have fed into the supply and demand for the share (and therefore under our simple supply and demand diagram) have set the price.
Describe semi - strong form EMH
takes things a bit further by arguing that any information which is in the public domain is automatically taken into account by the market and that this process happens quickly. This would include any financial information published by a company such as annual report and accounts, profit statements etc. This being the case, no outperformance would be possible by using any of this
information. The research evidence is less conclusive here, though it would seem that this holds true for most markets.
Again, there are many different people analysing this information and so the price will be impacted by the demand this creates
Describe strong form EMH
takes it to the conclusion by arguing that the price includes all information that could be obtained – not just the financial and trading information but also private
information such as that which can be obtained from interviewing company directors or their advisers. This is
where things get a little less supported by research.
What is the efficient market hypothesis
This model suggests that where a market operates efficiently, all investors will have access to all relevant information and that it will not be possible over time to deliver consistent outperformance simply through analysis. It suggests that all of the factors which would be revealed through analysis are already factored into the market price.
This means that however good you are at analysing investments, it should be impossible for you to achieve outperformance other than by luck. If this theory holds true, there would be little point in investing in anything other than tracking funds since active fund managers would be unable to achieve superior returns
