Efficient market theory


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Efficient Market Theory

A controversial model on how markets work. It states that the market efficiently deals with all information on a given security and reflects it in the price immediately. The model holds that technical analysis, fundamental analysis, and any speculative investing based on them are useless. The model has three forms: weak efficiency, which holds that technical analysis is ineffective, semi-strong efficiency, which holds that fundamental analysis is ineffective, and strong efficiency, which states that even insider information is immediately reflected in the security prices. Investors and academics disagree on how well the model works.

Efficient market theory.

Proponents of the efficient market theory believe that a stock's current price accurately reflects what investors know about the stock.

They also maintain that you can't predict a stock's future price based on its past performance. Their conclusion, which is contested by other experts, is that it's not possible for an individual or institutional investor to outperform the market as a whole.

Index funds, which are designed to match, rather than beat, the performance of a particular market segment, are in part an outgrowth of efficient market theory.

References in periodicals archive ?
The literature offers a wealth of evidence both supporting and contradicting efficient market theory. But, most of the research agrees that the market is at least weak-form efficient with respect to past information.
Thus, Fama makes operational Samuelson's martingale requirement for properly anticipated prices by showing that it is possible to reject the martingale property (and hence, market efficiency) by using only a subset of the information available to any (or for that matter, all) investors, As Fama makes clear in his development of the strong, semi-strong, and weak versions of the efficient market theory, it is also possible for speculative prices to satisfy the martingale conditions for one information set but not to satisfy it for another.
In its strong form, efficient market theory posits that all information, whether public or not, is reflected in security prices.
The theory is not easy to sum up, but it is a convincing counter to the efficient market theory which may itself have contributed to the recent lift off in U.S.
prices stay at the level predicted by efficient market theory even as the informed's share of the wealth approaches zero.
The efficient market theory argues that, over time, the market will accurately evaluate all information on the firm and its outputs (Fama, 1974, 1991).
For the last twenty years, the most widely circulated academic theory about the stock market has been the "efficient market theory." The theory is simple: to know what the stock market will do tomorrow, you just toss a coin.
When he gets around to economics, Cochrane aims his blows at two points: Krugman's attack on the "efficient market theory" and his advocacy of "fiscal stimulus" for depressed economies.

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