Are stock markets informationally efficient?

In finance, the efficient market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects.

All that is required by the EMH is that investors' reactions be random and follow a normal distribution pattern so that the net effect on market prices cannot be reliably exploited to make an abnormal profit, especially when considering transaction costs (including commissions and spreads). Thus, any one person can be wrong about the market — indeed, everyone can be — but the market as a whole is always right.
There are three common forms in which the efficient market hypothesis is commonly stated — weak form efficiency, semi-strong form efficiency and strong form efficiency, each of which have different implications for how markets work.
[edit] Weak-form efficiency
No excess returns can be earned by using investment strategies based on historical share prices.
Weak-form efficiency implies that Technical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysis may still provide excess returns.
In a weak-form efficient market current share prices are the best, unbiased, estimate of the value of the security. Theoretical in nature, weak form efficiency advocates assert that fundamental analysis can be used to identify stocks that are undervalued and overvalued. Therefore, keen investors looking for profitable companies can earn profits by researching financial statements.
[edit] Semi-strong form efficiency
Share prices adjust within an arbitrarily small but finite amount of time and in an unbiased fashion to publicly available new information, so that no excess returns can be earned by trading on that information.

Semi-strong form efficiency implies that Fundamental analysis techniques will not be able to reliably produce excess returns.
To test for semi-strong form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner.

[edit] Strong-form efficiency
Share prices reflect all information and no one can earn excess returns.

If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. Studies on the U.S. stock market have shown that people do trade on inside information.[citation needed]





To test for strong form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. Even if some money managers are consistently observed to beat the market, no refutation even of strong-form efficiency follows: with tens of thousands of fund managers worldwide[citation needed], even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers.




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