In this article, Eugene F. Fama presents a review of theory and empirical work related to the efficient markets hypothesis. Fama defines a market as "efficient" when the prices at any time fully reflect available information. As a consequence, the prices of this ideal market would provide precise signals for resource allocation. The empirical work related to the theory of efficient markets can be divided into three categories depending on the nature of the information subset. In the weak form tests, the information subset is the historical price or return time series. In the semi-strong form tests, the information subset of interest includes all publicly available information, such as earning announcements, new issues of common stock and share splits. Finally, the strong-form tests are associated with whether "investors or groups have monopolistic access to any information relevant for price formation". Most of the empirical tests are based on the assumption that the conditions of market equilibrium can be stated in terms of expected returns.
The results of the weak form tests strongly support the efficient market hypothesis. Semi-strong form tests have also supported the efficient markets theory. For example, Ball and Brown and Scholes find that the information contained in annual earnings announcements and new issues of common stock are on average fully reflected in the price. Fama suggests that the strong-form efficient markets model is probably best viewed as a benchmark against which the deviations from market efficiency can be analysed. Deviations from market efficiency in this extreme model have been observed. For instance, Scholes finds that corporate insiders often have monopolistic access to information about their firms.
Some questions derived from the review of the article are:
(1) Why is the market efficiency hypothesis important for the primary role of the capital market?
(2) What are the characteristics of an expected return or "fair game" efficient markets model?
(3) What are the potential sources of market inefficiency?
(4) What other deviations from market efficiency can be observed under the strong-form model?
(4) What other deviations from market efficiency can be observed under the strong-form model?
(5) Is George Akerlof right in considering the use of models based on the efficient market hypothesis as one of several factors that promoted the crash of 2008? (http://www.youtube.com/watch?v=HFpEbtrV8Ec&feature=related)
The article can be found here:
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