Efficient Market Hypothesis

The theory that asset prices fully reflect all available information at all times.

The Efficient Market Hypothesis (EMH) is the cornerstone of modern finance. It claims that stock prices always incorporate all available information, making it impossible to 'beat the market' consistently through analysis, market timing, or insider knowledge (strong form). Three forms: Weak: Prices reflect all past trading data (technical analysis doesn't work). Semi-strong: Prices reflect all public information (fundamental analysis doesn't work). Strong: Prices reflect all information, public and private (insider trading doesn't work — empirically false). Implications: If markets are efficient, active management is futile — just buy index funds. Criticisms: Behavioral biases (overreaction, momentum), market anomalies (value premium, size effect), and bubbles/crashes challenge EMH. Most evidence supports semi-strong efficiency for liquid large-caps, but inefficiencies exist in small-caps and emerging markets.

Related Terms

Portfolio Alpha (Jensen's)

Excess return after adjusting for market risk — the holy grail of active management.

Sharpe Ratio

Risk-adjusted return: excess return divided by volatility.