The Development of Efficient Market Hypothesis

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The Development Of Efficient Market Hypothesis

Xiao Yang

FIN 790 Spring 2013
January 30, 2013

For many years, many economics have been interested in developing and testing models of stock price behaviour. Market Efficiency is one of the important financial theories on stock price behavior. Many basic financial theories, such as Capital Asset Pricing Model (CAPM), Portfolio Theory, and Option Pricing Model are based on Market Efficiency. The Efficient Market Hypothesis( EMH ) is an economic theory on the efficiency of capital markets. In the year of 1970, the EMH was first officially formed by Fama in the article of "Efficient Capital Markets: Theory and experience Research", which expounded Fama's EMH. And this article is generally believed to be the milestone on the study of how stock market price performs or reflects all kinds of available information and how stock markets prices rapidly adjust to any new information efficiently. EMH states that in an open and efficient market, security prices should fully reflect all available information and prices rapidly according to any new information. As a result of efficient market, market prices are always ‘correct’ for securities and reflect the best available estimate of their true intrinsic worth. Investors who agree with this statement tend to buy index funds that track overall market performance. In his point, Fama believes that there are three different efficiency market patterns according to the degree on how security prices reflects the information. The three different efficiency market patterns are: 1) weak form of efficiency market (price fully reflects the historical information); 2) semi-strong form of efficiency market (prices fully reflect all publicly available information); 3) strong form of efficiency market(prices fully reflect public information and non-public information). In short, the theory of the...
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