Question

Explanation of the Efficiency Market Hypothesis (EMH).300 words

Answer 1

Answer)

The efficient market hypothesis (EMH) is an economic and investment theory that attempts to explain how financial markets move. It was developed by economist Eugene Fama in the 1960s, who stated that the prices of all securities are completely fair and reflect an asset’s intrinsic value at any given time. It is also known as Efficient Market Theory. In simple words it is a market that is efficient in processing information. The market can quickly and correctly adjust to new market informtion. EMH helps to explain the valid rationale of buying passive mutual funds and exchange-traded funds (ETFs). According to the defination of EMH, an efficient market can exist if the following conditions are satisfied:

• All investors have costless access to currently available future information.
• All investors are capable analysts.
• All investors pay close attention to market prices.

There are three different forms of the efficient market hypothesis:

1. Weak
2. Semi-strong
3. Strong

• Weak form EMH: assumes that the current market price reflects all historical price information about a security’s price. The argument for weak EMH is that all new price movements are unrelated to historical data. If a market is deemed to be ‘weak-form efficient’, it would mean that no correlation exists between historical prices and successive prices.
• Semi-Strong Form EMH: Implies that neither fundamental analysis nor technical analysis can provide an advantage to an investor and that new information is instantly priced in to securities.Those who believe semi-strong form EMH would question the need for a large portion of financial services, such as analysts and investment researchers.
• Strong Form EMH. Says that all information, both public and private, is priced into stocks and that no investor can gain advantage over the market as a whole. Both technical and fundamental analysis would be rendered moot, as neither could provide advantageous information.