Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis (EMH) is an investment theory that states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. In an efficient market, competition among investors and traders will drive prices to their fair value, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. The EMH suggests that it is impossible to outperform the market without taking on additional risk.
History of the Efficient Market Hypothesis
The EMH was first proposed by Eugene Fama in his 1970 paper, “Efficient Capital Markets: A Review of Theory and Empirical Work”. Fama argued that the markets are informationally efficient, meaning that the prices of securities already reflect all available information. Fama’s paper was a response to the work of other economists, such as William Sharpe and Harry Markowitz, who had argued that investors could outperform the market by using sophisticated portfolio selection techniques.
Since Fama’s paper, the EMH has been the subject of much debate and research. While some researchers have argued that the EMH is a valid theory, others have argued that it is too simplistic and does not take into account the complexities of the stock market. Despite the debate, the EMH remains a popular theory among investors and is often used as a basis for investment decisions.
Table of Comparisons
| Investment Theory | Outperform Market | Additional Risk |
|---|---|---|
| Efficient Market Hypothesis | Impossible | Yes |
| Random Walk Theory | Impossible | No |
| Technical Analysis | Possible | Yes |
Summary
The Efficient Market Hypothesis (EMH) is an investment theory that states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. The EMH suggests that it is impossible to outperform the market without taking on additional risk. For more information about the EMH, investors can visit websites such as Investopedia, The Balance, and Investing Answers.
See Also
- Random Walk Theory
- Technical Analysis
- Market Efficiency
- Portfolio Selection
- Capital Asset Pricing Model (CAPM)
- Arbitrage Pricing Theory (APT)
- Behavioral Finance
- Value Investing
- Growth Investing
- Fundamental Analysis
