Assumptions
- Large number of investors operating in the market for profit
- New information arrives randomly
- Prices adjust quickly
- Prices reflect all available information
Three forms of the EMH
1) The weak form of the EMH
- Says that future prices cannot be predicted by analysis of previous (historical) prices
- The idea here is that the current price reflects all the information we might know - so just by looking at these historical prices you can’t predict what is going to happen next
- It is silent on fundamental or insider information
- This does leave room for Fundamental Analysis
2) The semi-strong version of the EMH
- Suggests that prices adjust immediately to new public information
- So if semi-strong is correct that would seem to prohibit even fundamental analysis because the prices adjust quickly
3) The Strong version of EMH
- Says we can’t even make money on insider information - it can’t be leveraged!
- Prices reflect all information public and private
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If the strong version of the EMH is true, it is essentially impossible to make money by holding a portfolio other than the market portfolio
EMH
