Efficient market hypothesis was developed by fama in 1970 and according to fama the efficient market hypothesis has three forms.

Three Forms of EMH

  • Weak form of efficient market
  • Strong form of efficient market
  • Semi-strong form of efficient market

1. Weak Form of Efficient Market

The current prices of the security reflect all security market. Information including the historical prices, the rates of return, traditional volume data and other market generated data. This implies that the past rates of return should have no relationship with future rates of return. In weak form of efficient market above average return is earned.

The weak form of efficient market hypothesis says that you cannot predict future stock prices on the basis of past stock prices. Weak-form EMH is a shot aimed directly at technical analysis. If past stock prices don’t help to predict future prices, there’s no point in looking at them — no point in trying to discern patterns in stock charts.

2. Semi-Strong Form of Efficient Market

When the current security prices reflect all the public information including market and non-market information. This implies that decisions made on new information after it is made public with not result into any above the average profit. In semi strong form of efficient market no return is earned above average.

The semi-strong form of EMH says that you cannot use any published information to predict future prices. Semi-strong EMH is a shot aimed at fundamental analysis. If all published information is already reflected in a stock’s price, then there’s nothing to be gained from looking at financial statements or from paying somebody (i.e., a fund manager) to do that for you.

Related Topic: Tests for the Semi Strong Market - Time Series Test & Event Test

3. Strong Form of Efficient Market

The stock prices should reflect all the public and private information. This implies that no group of investor should be able to earn above average return consistently. This also implies that the transaction costs are minimum.

The strong form of EMH says that everything that is knowable — even unpublished information — has already been reflected in present prices. The implication here would be that even if you have some inside information and could legally trade based upon it, you would gain nothing by doing so.

corporate finance

October 07, 2019