Efficient Market Hypothesis (EMH)

The Efficient Market Hypothesis (EMH) is an economic theory or hypothesis that suggests that financial markets are efficient and reflect all available information. According to EMH, financial markets are efficient when everyone has equal access to available information and can effectively use that information.

EMH was developed by Eugene Fama in the 1960s. Essentially, EMH states that financial markets accurately reflect true prices based on available information, making it difficult or impossible to consistently profit from information-based strategies in the markets.

There are three different versions of EMH:

1. Weak Form EMH: According to this version, financial markets are weak-form efficient. This means that it is not possible to predict future price movements by analyzing past price movements or conducting technical analysis. Past price movements only reflect current prices and do not provide additional information to predict future price movements.

2. Semi-Strong Form EMH: According to this version, financial markets are semi-strong-form efficient. This means that it is not possible to predict future price movements by analyzing both past price movements and general market data. Since everyone has equal access to this information, there are no opportunities left in the market.

3. Strong Form EMH: According to this version, financial markets are strong-form efficient. This means that even with the use of past price movements, general market data, and private information, it is still not possible to predict future price movements. Access to private information is limited as not everyone has equal access, and therefore, it does not provide any advantage in the market.

According to EMH, prices in financial markets are determined by the interaction of rational investors. These investors make buying and selling decisions based on available information, resulting in prices that reflect all available information in the market. The inability to predict prices effectively, according to EMH, leads to random market movements and price fluctuations.

While EMH is a theory that supports efficiency and effectiveness in financial markets, it has also faced criticism. Some critics argue that occasional irrational behavior is observed in markets, suggesting that EMH is not entirely valid. Additionally, some research has shown the existence of information asymmetry and mispricing in markets.

In conclusion, EMH is a hypothesis that supports the efficiency and effectiveness of financial markets. However, it is a controversial hypothesis that may not fully align with the reality of financial markets.