Question

Briefly outline the three main forms of market efficiency under the EMH.

Answer 1

The efficient market hypothesis (EMH) postulated by Eugene Fama, states that stock prices trade at fair value incorporating all available information hence it is impossible to beat the market. The theory has three main forms, presented below:

• Weak form of efficiency : The primary claim is that the stock prices already reflect all the publicly available information hence any kind of technical analysis will not be helpful in predicting future price movements since the price movements will have no bearing to past historical prices but will move immediately to reflect the public information about the companies. The stock price are expected to move randomly and it states that the traders cannot systematically profit from the price movements.
• Semi strong form of efficiency: It contends that stock prices incorporate not only public information but also non-market information which may be arrived at by doing fundamental analysis since the stock prices immediately factor in all information into the prices. Hence it goes step ahead from weak form that neither technical nor fundamental analysis will be helpful to beat the markets
• Strong form of efficiency: This states that forms of information - public, non market and insider information - is already factored and hence no person should be able to systematically beat the markets.