Efficient Market Hypothesis

1
Chapter 12

• Efficient Market Hypothesis

2
Efficient Markets

• In an efficient stock market, the price for any
  given stock effectively represents the expected
  net present value of all future profits
• Interplay of supply and demand sets prices
• Price for any stock or bond represents collective
  wisdom about future prospects

3
Efficient Markets Hypothesis

• EMH holds that security prices fully reflect all
  available information at any time.
• Individual and professional investors buy and
  sell stocks under assumption that intrinsic value
  differs from market price.
• Perfectly competitive securities market
• New information arrives at market independently
  and randomly.
• Both buyers and sellers adjust rapidly to new
  info.
• Current security prices reflect all relevant
  risk/return info.

4
Levels of Market Efficiency

• Weak-Form Hypothesis current prices reflect all
  stock market information trading rules based on
  past stock market return or volume are futile.
• Semistrong-Form Hypothesis current prices
  reflect all public information trading rules
  based on public information are futile.
• Strong-Form Hypothesis current prices reflect
  all public information and non-public
  information. All trading rules are futile.

5
Public vs. Private Information

• Stock Market Information stock price and trading
  volume figures
• Public Information freely shared information
• Nonpublic Information proprietary data
• Insider Information proprietary information
  within a firm