See Also:
Economic Indicators
Economic Value Added
Supply and Demand Elasticity
Business Cycle
Porters Five Forces of CompetitionEfficient Market TheoryEfficient market hypothesis proposes that financial markets incorporate and reflect all known relevant information. The validity of efficient market hypothesis is debated. Whether or not efficient market hypothesis is valid, it is useful as a theoretical concept with which to study financial market phenomena.
Efficient Market AssumptionsEfficient market hypothesis is based on several assumptions. Efficient market hypothesis assumes that all relevant information is reflected in the stock markets. Efficient market hypothesis assumes a financial security is always priced correctly. This implies that stocks are never undervalued or overvalued. It also implies that investors can never consistently outperform the overall market, or “beat the market,” by employing investment strategies.
Degrees of Efficient Market Hypothesis According to efficient market hypothesis, there are three forms of market efficiency: weak-form efficiency, semi-strong-form efficiency, and strong-form efficiency. The different forms represent different degrees of adherence to efficient market hypothesis.
Weak Form Market Efficiency According to weak-form market efficiency, all historic price data are reflected in a stock’s current market price. This implies that technical analysis cannot be used to outperform the overall market. However, this form of market efficiency does allow for security mispricings that investors can discover and exploit through fundamental analysis.
Semi Strong Efficient Market HypothesisAccording to semi-strong-form market efficiency, all public data (including all historical data and all current financial statement data) are reflected in a stock’s current market price. This implies that neither technical analysis nor fundamental analysis can be utilized to outperform the overall market. However, this form of market efficiency does allow for security mispricings due to private information, so investors with access to private information may be able to earn excessive returns.
Strong Form Market Efficiency According to strong-form market efficiency, all data – historic and current, public and private – are reflected in a stock’s current market price. This form of market efficiency implies that there is no way to achieve excessive returns in financial markets.