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Efficient Market Hypothesis

📈 Economics By CampusDown Wiki Editorial Team Last updated
Quick answer: The efficient market hypothesis says that asset prices already reflect available information, so investors cannot consistently earn above-average risk-adjusted returns by trading on that information.
Contents
  1. 1. Overview
  2. 2. Three forms
  3. 3. Random walks and what it means for investors
  4. 4. The joint hypothesis problem
  5. 5. Criticism
  6. 6. References

Overview

The efficient market hypothesis (EMH) concerns how quickly and accurately financial-market prices reflect information. Samuelson (1965) proved that properly anticipated prices fluctuate randomly, and Fama (1970), reviewing the empirical work to date, defined an efficient market as one in which "prices always fully reflect available information". Fama shared the 2013 Nobel Memorial Prize in Economics for this work, together with Robert Shiller, one of the hypothesis's best-known critics.

Three forms

  • Weak form: past prices and trading volume are already reflected, so technical analysis based on charts cannot reliably earn excess returns.
  • Semi-strong form: all public information, such as financial statements, disclosures and news, is reflected quickly, so fundamental analysis of public data cannot consistently beat the market either. Event studies of price reactions to earnings announcements are the classic test.
  • Strong form: all information, including insider information, is reflected. Because insiders can profit from trading, the strong form is generally not supported.

Random walks and what it means for investors

New information arrives unpredictably, so in an efficient market price changes come close to a random walk. This reasoning became the theoretical basis for passive investing, such as index funds that simply hold the whole market. The hypothesis does not say prices are always "right"; it says that pricing errors cannot be systematically exploited using available information.

The joint hypothesis problem

Testing efficiency requires an asset pricing model to define a "normal" return. When excess returns turn up, one cannot tell whether the market is inefficient or the model is wrong, which Fama (1991) called the joint hypothesis problem.

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Criticism

  • Grossman–Stiglitz paradox (1980): if prices fully reflected information, nobody would pay to gather it, and then it could not get into prices. Perfect efficiency is therefore impossible; enough inefficiency must remain to reward information gathering.
  • Excess volatility: Shiller (1981) showed that stock prices swing far more than later changes in dividends can justify.
  • Anomalies and behavioral finance: momentum, the small-firm effect, bubbles and crashes are often explained by investor biases and limits to arbitrage.

Today the debate is less about whether markets are perfectly efficient or not and more about how efficient they are. The logic of diversification is covered in modern portfolio theory.

Sources reviewed: 2026-10-16

References

  1. Samuelson, P. A. (1965). Proof that properly anticipated prices fluctuate randomly. Industrial Management Review, 6(2), 41–49.
  2. Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. Journal of Finance, 25(2), 383–417.
  3. Grossman, S. J., & Stiglitz, J. E. (1980). On the impossibility of informationally efficient markets. American Economic Review, 70(3), 393–408.
  4. Shiller, R. J. (1981). Do stock prices move too much to be justified by subsequent changes in dividends? American Economic Review, 71(3), 421–436.
  5. Fama, E. F. (1991). Efficient capital markets: II. Journal of Finance, 46(5), 1575–1617.

Reports and materials that use this theory (Korean)

There are no materials dedicated to this theory yet, but you can search related reports in the CampusDown library (Korean).

Find more reports · Search '효율적 시장 가설' on CampusDown →
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This article was last updated on October 16, 2026. It is based on widely recognized original works and textbooks; when citing it in a paper, please check the original sources listed in the references.