The Efficient-Market Hypothesis

What Is The Efficient-Market Hypothesis?

The efficient-market hypothesis is the theory that the prices of financial assets already reflect all available information, so that at any moment a security's price is a fair estimate of its value given what is known. Associated with economist Eugene Fama, the hypothesis implies that it is extremely difficult to consistently outperform the market using information that is already public, because any such information is quickly incorporated into prices. New information moves prices, but new information is by definition unpredictable. In its stronger forms the hypothesis suggests that patterns investors think they see are largely illusory, and that beating the market reliably owes more to luck than to skill.

Why It Matters

The efficient-market hypothesis has been enormously influential and enduringly controversial. It provided the intellectual case for low-cost index investing and shaped how economists model financial markets. But it sits in tension with behavioral economics, which finds that investors are prone to systematic errors and that prices can drift from fundamentals. Robert Shiller's research on market volatility and asset bubbles directly challenges the hypothesis, and in a striking illustration of the debate he shared the 2013 economics prize with Eugene Fama, whose efficient-market work his own findings question. The clash between efficient markets and behavioral finance remains one of the central unresolved arguments in the study of asset prices.