Efficient Market Hypothesis (EMH): Definition, Forms & Importance
5paisa Research Team
Last Updated: 05 Nov, 2024 03:23 PM IST

Content
- Efficient Market Hypothesis (EMH)
- What is the Efficient Market Hypothesis?
- The Different Forms of EMH - Efficient Market Hypothesis
- EMH and Investing Strategies: What This Means for Investment Strategies
- Assumptions of Efficient Market Hypothesis
- Arguments for and Against the EMH: Why People Disagree About EMH
- Impact of the EMH: How EMH Impacts the Financial World
- Importance of Efficient Market Hypothesis
- EMH Limitations: The Limits of Efficient Market Hypothesis
- Random Walk Theory vs. Efficient Market Hypothesis
- Conclusion
Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis (EMH) is a theory suggesting that asset prices in financial markets quickly and fully reflect all available information. Basically, this means no investor should consistently "beat the market" because prices adjust almost instantly when new information comes out. This idea came from economist Eugene Fama in the 1960s and has been a huge influence in the world of finance.
Let’s break down what EMH is, the different types, arguments around it, and how it influences investing.
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Frequently Asked Questions
The Efficient Market Hypothesis was first developed in the 1960s by economist Eugene Fama. His work, which earned him a Nobel Prize in 2013, helped shape the way financial markets are viewed today, arguing that it’s almost impossible to beat the market on a consistent, risk-adjusted basis.
In the real world, EMH is mainly used as the basis for passive investing. For example, index funds and ETFs have gained popularity because many investors believe that trying to pick stocks that outperform the market is generally not worth the time or cost. A well-known example is Vanguard, a pioneer in passive investing, offering funds that mimic the broader market without the expense of active management.
A financial market is considered efficient when the financial assets’ prices correctly reflect all available information at any given time. This indicates that the new info such as company’s financial performance, economic indicators or geopolitical events is quickly incorporated into asset prices. In an efficient market, it is nearly impossible for investors to outperform the market consistently – because the price movements of assets cannot be predicted appropriately.
Generally, for most practical uses, Efficient Market Hypothesis is considered to be a good working model – even if it is not absolutely right. However, EMH’s validity has been questioned on both, empirical and theoretical grounds. Interestingly, some investors like Warren Buffet have beaten the market whose strategy of investing in undervalued stocks has made him billions.
EMH – Efficient Market Hypothesis is a trading concept and theory that suggests investors cannot outperform the financial market consistently. According to EMH, markets are informationally efficient, which means that asset prices reflect all available info at any given time. This is the reason why it is not possible for investors to generate higher returns consistently than the average market return.