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Introduction - Efficient Market Hypothesis (EMH)

The efficient market hypothesis (EMH), created in the 1970s by Eugene Fama, is an investment theory that states it is impossible to "beat the market," because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing. It states that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis.

While academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example, investors such as Warren Buffett have consistently beaten the market over long periods of time, which should be impossible, according to the EMH. Detractors of the EMH also point to events, such as the 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, as evidence that stock prices can seriously deviate from their fair values.

Relevant Articles:

Modern Portfolio Theory (MPT)


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