Efficient Market Hypothesis

On 08/19/2011, in Investment Concepts, by Jordan Wilson

Within investing theory, there is a lot of consideration to the Efficient Market Hypothesis (EMH).

That is, how efficient are the investment markets and can smart investors exploit any inefficiencies to profit.

Phil Maymin, an Assistant Professor of Finance and Risk Engineering at the Polytechnic Institute of New York University, provides an interesting take on market efficiency in the video below. 

Three Forms of Market Efficiency

EMH recognizes three forms of market efficiency: weak, semi-strong, strong.

Of the three forms, I subscribe more to a semi-strong or higher form.

I think markets are at least weak form efficient which is one reason I am not a fan of technical analysis. A weak form market is one where all historic data is reflected in the asset price.

A lot of technical analysis involves examining past price results and trends contained therein. Technicians believe that these past trends may occur in the future allowing for profits to be made. I know some decent technical people, but I personally do not believe that profits can be made consistently and over the long-term through technical analysis.

I also think that most markets are semi-strong form efficient. That is, asset prices reflect all publicly available information.

Given the extensive corporate reporting requirements, the sheer number of competent investors and analysts tracking companies, and the complex analytical tools available to all investors, I believe publicly available information is processed (almost) instantaneously and reflected in asset prices. As such, there is little, if any, opportunity to exploit new information for profit.

As for strong form efficiency, I have my doubts. Strong form is where even private information is reflected in the asset price.

If strong form is present, then even those trading on insider information would not be able to prosper. In almost, if not, all markets, I still think there is the opportunity to make money by trading on private information. However, some securities commissions do a better job than others in monitoring for insider trading and levying harsh sanctions against guilty parties. So in some jurisdictions, the threat of penalties does an effective job of limiting those taking advantage of proprietary knowledge.

Note though that a market is not a market is not a market. The New York Stock Exchange is not the over-the-counter (OTC) market in Zimbabwe (or the United States OTC market for that matter). The relative efficiency of one market may well differ from another based on the reporting requirements of the exchange, securities commission, government, etc., and the general business environment in which a company is based.

In the video, the main discussion on market efficiency commences about the 8:20 mark. Prior to that though, is an interesting take on genius.

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