EMH Flashcards
What is the EMH?
Theory that markets process information efficently, meaning securities always trade at their intrinsic value.
What cannot be generated under the assumptions of the EMH?
Excess Returns (alpha)
What are the three assumptions of the EMH:
1) Large number of active, rational, market participants (analyse and value securities)
2) New information is released in a random fashion
3) Market participants respond instantly to new information (with no cognitive biases)
What happens as a result of the three assumptions?
Unpredictable release of information and large active investors =
Prices move in a random and unpredictable manner (Random walk theory)
What are the three forms of market efficiency?
1) Weak Form
2) Semi-Strong
3) Strong
What is priced into a security under weak form
Historic market information - which cannot be predictive of future price
What theory is associated with weak form and why?
Random Walk Theory
Past information cannot be used to predict future prices, as such, stock prices follow a random walk.
According to weak form EMH, what investment strategy cannot return alpha?
Technical analysis
What is priced in under semi-strong form EMH?
All Public and historic information.
What investment strategies do not work under semi strong form
Technical and Fundamental analysis
According to semi-strong form, how can returns be generated?
1) Use of insider / private information.
2) Analyst mosaic / pre-announcement drift
What is priced in under strong form efficiency?
All information, historic, public and private.
What does strong form efficiency argue?
Excess returns cannot be generated.
There is no point to active management under this view.
What argument supports strong form efficiency?
Most active managers underperform their benchmark.
Give 2 arguments that argue against the EMH
1) Markets are driven by humans who are not rational
2) Some investors consistently outperform the market e.g. Warren Buffett.
