efficient market hypothesis
Efficient Market Hypothesis
It states that because rational expectations are quickly reflected in prices, price fluctuations cannot be predicted.
Prices quickly reflect “all available information” about a good, and therefore, using that information, it is impossible to beat market returns over the long term. This theory is known to have been first proposed by Eugene Fama, who later won the Nobel Prize in Economics.
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There are many participants in the market, and they have largely equal access to relevant information. They are smart, objective, motivated, and spare no effort. The analytical models they use are widely known and already in use.
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Because of the collective efforts of market participants, all information is immediately and fully reflected in the market price of each asset. Also, since participants will immediately buy assets that are undervalued and immediately sell assets that are overvalued, asset prices are set fairly in both absolute and relative terms.
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Therefore, market prices are an accurate assessment of an asset's intrinsic value, and no participant can persistently find mispriced assets and profit from them.
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Therefore, an asset sells at a price expected to earn an appropriate risk-adjusted return relative to other assets. The riskier the asset, the higher return it must offer to attract buyers. Once the market sets prices and those prices prevail, it will offer no 'free lunch.' In other words, without an increase in risk, returns will not increase.
Topics: economic theory,Eugene Fama
Opposite: Adaptive Market Hypothesis
Category: Wiki/Economy