The Efficient Market Hypothesis

Topics: Stock market, Fundamental analysis, Random walk hypothesis Pages: 2 (419 words) Published: May 11, 2009
The Efficient Market Hypothesis(EMH) was first given by Samuelson(1965),Fama(1965) and Mandelbrot(1966).It was based on “Random walk Theory”, and stated that since the market price will be affected by new information in the market, all available information have been fully reflected on the security price.

There are three assumptions for the Efficient Market Hypothesis: 1.All investors are independent, rational, well-informed and hope for the highest profit; 2.All information are free and randomly available in the market, that’s mean no one can predict any new information. Once the information is released in the market, the price will be responded as soon as possible; 3.There are no taxes or transaction fees in the market.

Under these three assumptions, since everything we know today is already reflected in the price, and it will be responded to the new information immediately, so that the movement of stock prices in the future can not be predicted, and it will fluctuate randomly.

According to difference efficiency of information reflection in the market, Fama(1070) divided EMH into three levels:

1. Weak-Form efficiency
It believes that all the historical information, for example strike price, trading volume and the past price movement have been fully reflected in the current stock prices. If Weak-Form efficiency comes into existence, it is no benefit to analysis the movement of historical price, technical analysis will be fail.

However, inventors still possible to get super-normal profit by fundamental Analysis, which estimates the “true” value of a stock by analysis NPV and financial statement, and gains profit by trading the mispriced stock in the Market.

2. Semi-Strong efficiency
It states that all the publicly available information, including historical price, annual reports and announcement of earnings, have been reflected on the current stock price. In this case, both fundamental and technical analysis will be fail. Since stock price...
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