The concept of
efficient market hypothesis states that the financial markets are efficient when they provide information explicitly. Under this concept the costs on the traded assets like property, stocks or bonds show the known information. Hence, the markets are unbiased as they represent the combined beliefs of all the investors regarding the future prospects.
It was Professor Eugene Fama who developed the efficient market hypothesis in the early phase of 1960s. He developed the theory in the form of an academic concept of study by using his published thesis of Ph.D. in the University of Chicago Graduate School of Business. According to the efficient market hypothesis, it is not possible to exceed the overall market with the already known information. The only way that an investor can possibly obtain higher returns from such a market is by purchasing riskier investments. The information or news in the efficient market hypothesis is defined as anything that may affect prices, which is transcendent in the present and thus appears in the future randomly.
According to the EMH, it can also be concluded that the stocks are always traded at their fair value on stock exchanges. Hence, it is impossible for the investors to purchase an undervalued stock or sell the stocks at inflated prices in such circumstance.
The efficient market hypothesis is generally stated in three common forms:
- Weak Form Efficiency
- Semi-Strong Form Efficiency
- Strong Form Efficiency
Each of the above stated forms of efficient market hypothesis exert different implications for the market. A study on these three common forms of market efficiency will make people understand the theory properly.
There are arguments involved with the validity of efficient market hypothesis. Some observers question on the market to behave consistently with this hypothesis. Some economists and mathematicians believe that a man made market is affected by various factors and cannot behave according to the efficient market hypothesis. When there are some surprising changes in the market, the imperfection in the efficient market hypothesis becomes most evident.