What is Efficient Market Hypothesis (EMH)?

Efficient Market Hypothesis (EMH): 

This theory is developed by economist Eugene Fama in 1960. The efficient market hypothesis states that the price of securities reflected all the information at any point in time. It is impossible to beat the market because all the information are quickly incorporated into the assets so, there is no any new information which helps the investors to earn any gain from market or forecast any price movement in future. In market investors traded securities with same interest and closely analysing the market to earn any gain from price movements but the securities are traded in fair price in market the chances to gain is impossible.

Three degree of efficient market hypothesis:

·         Weak form of efficient market hypothesis

·         Semi-strong form of efficient market hypothesis

·         Strong form of efficient market hypothesis

In weak form of EMH all past information are incorporated into the securities at any point in time like past prices of the security, dividend paid in past etc. All such information is used to set the price of security so that, they are traded in fair price in market. No new information is available for the investors with the help of which they can earn profit from market. The assets are traded in fair price so there is no undervalued or overvalued assets with the help of which investors earn profit in market.

In semi- strong form of EMH all publicly available information are reflected in the price of security at any point in time. This form does not only include publicly information but also include other information like financial status of a company etc. So, the price of a security reflects the all the information and therefore investors don’t get chance to outperform in the market.

In strong form of EMH all private and public information are incorporated into the assets at any point in time. No one can take advantage from the market because there is no any new information available in a market which helps to forecast future changes in a price of a security. All the information is incorporated in a security price including private information that’s why it is a strong form of efficient market hypothesis.

Assumptions of an efficient market hypothesis:

Investors are rational.

Markets are rational.

There is no transaction cost, taxation etc.

In weak form of EMH the security prices reflect the past information that’s why it is known as weak form because no current information are used to decide the price of security.

In semi-strong form of EMH all publicly available information are incorporated in securities price but it does not uses the private information in it.

In strong form of EMH all private or insiders’ information and public information are incorporated in securities price so, there is no other information are available for investors to use it to earn some profit from market.

Implication of Efficient Market Hypothesis:

·         The securities are traded in fair price which reflects all information whether it is private or public.

·         It is difficult to outperform the overall market through stock selection and market timing.

·         Investors can randomly select the diversified portfolio and there is no need to change it.

·         Financial managers have to analyse the market situation according to the information goes public.