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Efficient Market Hypothesis: prices of securities in financial markets fully reflect all available
information.
Example of EMH:
Suppose Microsoft closed with share price of $90 today. However, overnight news came that
they were predicted to reach $120 next year. Equilibrium return rate of Microsoft is 15%. What
does EMH indicate price of Microsoft will be when it opens today?
We know Rof is 15% and Pof is 120. Thus 0.15 = (120-Pt)/Pt. Solving for price today we get
$104. Thus microsoft should open today at $104.
Evidence of EMH
- Performance of Investment Analysts and Mutual Funds
- Having performed well in the past does not indicate that an investment manager
will perform well in the future
- It has been shown that investment managers tend to not do better than a
randomly selected portfolio
- This shows that it is incredibly difficult to select winners, proving the EMH
- Stock Prices Tend No to Reflect Publicly Available Information
- Stock prices should reflect all public information
- It has been shown that stocks typically do not increase that much when good
news is reported
- Random Walk of Stock Prices
- EMH means that stock prices are completely unpredictable
- Stocks move randomly
- Failure of technical analysis