Course 502: Efficient Market Theory
What Efficient Market Theory Is
In this course
1 Introduction
2 What Efficient Market Theory Is
3 The Conclusions of Efficient Market Theory
4 Strikes Against Efficient Markets Theory
5 The Upshot

Efficient market theory--or as it's technically known, Efficient Market Hypothesis--is an attempt to explain why stocks behave the way they do.

The hypothesis holds that stock prices reflect all the publicly available information about companies. Stock prices aren't necessarily "right," but they're as correct as they possibly could be. As a result, says Malkiel, "a chimpanzee throwing darts at The Wall Street Journal can select a portfolio that performs as well as those managed by the experts."

Given how broad the original Efficient Market Hypothesis (EMH) was, a noted academic, Eugene Fama, later divided the theory into three subhypotheses.

The weak-form EMH assumes that current stock prices fully reflect all historical information, including past returns. Thus investors would gain little from technical analysis, or the practice of studying a stock's price chart in an attempt to determine where the stock price is going to go in the future.

The semi-strong EMH form assumes that stock prices fully reflect all historical informationandall current publicly available information. Thus, investors gain little from fundamental analysis, or the practice of examining a company's financial statements and recent developments.

Finally, the strong-form EMH states that prices reflect not just historical and current publicly available information, but insider information, too. Investors therefore can't benefit from technical analysis, fundamental analysis, or insider information

Next: The Conclusions of Efficient Market Theory >>

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