The document discusses the efficient market hypothesis (EMH) which states that stock prices already reflect all available public information and it is impossible for investors to outperform the overall market through analysis. It presents the different forms of EMH from weak to semi-strong to strong form and argues prices adjust rapidly to new information. The random walk theory, which suggests stock prices move randomly, is explained by EMH since only new unknown information affects prices randomly. Arguments against EMH include that it cannot explain market bubbles and crashes.

1. Efficient market
Hypothesis(EMH)
By : Dr Nidhi Walia
Asst Professor, USAM
Punjabi University, PAtiala

2. EMH: Introduction
• According to the Efficient market hypothesis, stocks always
trade at their fair value on exchanges, making it impossible for
investors to purchase undervalued stocks or sell stocks for
inflated prices. Therefore, it should be impossible to outperform
the overall market through expert stock selection or market
timing, and the only way an investor can obtain higher returns is
by purchasing riskier investments.
• The efficient-market hypothesis (EMH) is a hypothesis
in financial economics that states that asset prices reflect all
available information. A direct implication is that it is impossible
to "beat the market" consistently on a risk-adjusted basis since
market prices should only react to new information.

3. • The Efficient Market Hypothesis (EMH) essentially says that all known
information about investment securities, such as stocks, is already
factored into the prices of those securities. Therefore, assuming this is
true, no amount of analysis can give an investor an edge over other
investors
• So, while an investor might get lucky and buy a stock that brings him huge
short-term profits, over the long term he cannot realistically hope to
achieve a return on investment that is substantially higher than the market
average.
• The major conclusion of the theory is that since stocks always trade at
their fair market value, then it is virtually impossible to either buy
undervalued stocks at a bargain or sell overvalued stocks for extra profits.
Neither expert stock analysis nor carefully implemented market timing
strategies can hope to average doing any better than the performance of
the overall market. If that’s true, then the only way investors can generate
superior returns is by taking on much greater risk.

4. • The efficient market hypothesis states that stock prices fully
reflect all available information and expectations, so current
prices are the best approximation of a company’s intrinsic
value. This would preclude anyone from exploiting mispriced
stocks consistently because price movements are mostly
random and driven by unforeseen events.

5. EMH vs RWH
• Random walk hypothesis was 1st esposed by French mathematician Louis
Bachelier in 1900, which states that stock prices are random, like the steps taken
by a drunk, and therefore, unpredictable. A few studies appeared in the 1930's, but
the random walk hypothesis was studied — and debated — intensively in the
1960's. The current consensus is that the random walk is explained by the efficient
market hypothesis.
• In the EMH, prices reflect all the relevant information regarding a
financial asset; while in Random Walk, prices literally take a ‘random
walk’ and can even be influenced by ‘irrelevant’ information.

6. The efficient market hypothesis (EMH) states that financial markets are efficient and that prices
already reflect all known information concerning a stock or other security and that prices rapidly
adjust to any new information. Information includes not only what is currently known about a
stock, but also any future expectations, such as earnings or dividend payments. It seeks to explain
the random walk hypothesis by positing that only new information will move stock prices
significantly, and since new information is presently unknown and occurs at random, future
movements in stock prices are also unknown and, thus, move randomly. Hence, it is not possible
to outperform the market by picking undervalued stocks, since the efficient market hypothesis
posits that there are no undervalued or even overvalued stocks

7. Summary
• information is widely available to all investors;
• investors use this information to analyze the economy, the
markets, and individual securities to make trading decisions;
• most events having a major impact on stock prices — such as
labor strikes, major lawsuits, and accidents — are random,
unpredictable events, and their occurrences are quickly
broadcast to investors;
• investors will react quickly to new information

8. Arguments against EMH
• Market bubbles and crashes

9. Random Walk Theory
• The Random Walk Theory assumes that the movement in the price
of one security is independent of the movement in the price of
another security.
• A “random walk” is a statistical phenomenon where a variable follows
no discernible trend and moves seemingly at random. Random Walk
Theory as applied to trading states that stock prices have random
movement so therefore, any attempt to predict future price
movement, either through fundamental or technical analysis, is futile.
The implication for traders is that it is impossible to outperform the
overall market average other than by sheer chance.
• Random walk theory infers that the past movement or trend of a
stock price or market cannot be used to predict its future movement.

10. • Random walk theory considers fundamental analysis
undependable due to the often-poor quality of information
collected and its ability to be misinterpreted.
• Random walk theory considers technical analysis
undependable because it results in chartists only buying or
selling a security after a move has occurred.
• Random walk theory claims that investment advisors add little
or no value to an investor’s portfolio.

12. Forms of EMH
• Weak Form EMH: Suggests that all past information is priced into
securities. Fundamental analysis of securities can provide an
investor with information to produce returns above market averages
in the short term, but there are no "patterns" that exist. Therefore,
fundamental analysis does not provide long-term advantage and
technical analysis will not work.
• Semi-Strong Form EMH: Implies that neither fundamental analysis
nor technical analysis can provide an advantage for an investor and
that new information is instantly priced in to securities.
• Strong Form EMH. Says that all information, both public and
private, is priced into stocks and that no investor can gain advantage
over the market as a whole. Strong Form EMH does not say some
investors or money managers are incapable of capturing abnormally
high returns because that there are always outliers included in the
averages.

13. Weak form of EMH
• The weak form suggests that today’s stock prices reflect all the data
of past prices and that no form of technical analysis can be
effectively utilized to aid investors in making trading decisions.
Advocates for the weak form efficiency theory believe that if
the fundamental analysis is used, undervalued and overvalued
stocks can be determined, and investors can research
companies' financial statements to increase their chances of making
higher-than-market-average profits.
• The basis of "weak form efficiency" is, as the qualifying phrase to all
investors by advisers always suggests: "past performance is no
guarantee of future results." In other words, future prices cannot be
predicted merely by reviewing past prices. So that excess returns -
or improved returns - cannot be made over time basing investment
strategy on historical share prices or other data.

14. Semi strong form of EMH
• The semi-strong form efficiency theory follows the belief that because all
information that is public is used in the calculation of a stock's current
price, investors cannot utilize either technical or fundamental analysis to
gain higher returns in the market. Those who subscribe to this version of
the theory believe that only information that is not readily available to the
public can help investors boost their returns to a performance level above
that of the general market.
• The basis of "semi-strong form efficiency" is that share prices adjust to
publicly available new information quickly, and in an unbiased manner, so
that no excess returns can be made trading on that information. A test of
this is reviewing consistent upward or downward price adjustments after
an initial piece of news hits. The movement and direction is believed to
indicate if investors interpreted the news in a biased way, which is
therefore "inefficient," or unbiased, which is "efficient."

15. Strong form of EMH
• The strong form version of the efficient market hypothesis states that all
information—both the information available to the public and any information not
publicly known—is completely accounted for in current stock prices, and there is
no type of information that can give an investor an advantage on the market.
• Advocates for this degree of the theory suggest that investors cannot make
returns on investments that exceed normal market returns, regardless of
information retrieved or research conducted.
• In "strong-form efficiency," all share prices reflect the entirety of available
information, both public and private, meaning no individual can make excess
returns, or "beat the market." This form of market efficiency isn't possible where
legal barriers exist to private information becoming public. An example of legal
barriers to private information becoming public is insider trading laws. The only
way in such an environment for strong-form efficiency is if barriers to private
information becoming public are ignored, so that prices reflect private as well as
public information.