KATHMANDU: Also known as Random Walk Theory, Efficient Market Hypothesis (EMH) is a concept developed by Eugene Fama in the year 1965. He stated that current market price fully reflects all available information, that is past prices, publicly available and inside information and there is no way an investor can earn excess profit by using this information. When new information arrives in the market, stock prices quickly adjusts to it, which is why the market is said to be efficient.
In order to get proper insights about EMH, one should know about its weak, semi-strong and strong form. The weak form of EMH states that the current market price reflects past prices as well as the volume information. It is termed as weak because it reflects that information which is easily available and accessible to the investor and such information does not help investors to out-perform the market. Investors believe “Technical Analysis”, help them forecast future price movement based on the past price, but EMH considers them useless.
The semi-strong form of EMH states that the current market price reflects publicly available information, that is, past price as well at the information related to company’s
financial statements, company’s announcement; economic factors, etcetera. No investor can think of outperforming the market with such publicly available information.
The strong form of EMH states that the current market price reflects private or insider information, that is, known but unpublished information. This states that if you have some inside information and could legally trade based upon it, you would gain nothing by doing so. For example: Corporate officers can buy their corporations’ stock, but they have to inform the government and that information is made public so that their purchase becomes a publicly known fact.
Therefore, investors or fund managers who think that they can outperform the market with the available information should first have a look at EMH.
(The author is the manager of R&D at MEX Nepal. She can be contacted through email@example.com)