The Efficient Market Hypothesis:
- Current prices incorporate all available information and expectations.
- Current prices are the best approximation of intrinsic value.
- Price changes are due to unforeseen events.
- “Mispricings” do occur but not in predictable patterns that can lead to consistent outperformance.
Professor Eugene F. Fama of the University of Chicago performed extensive research on stock price patterns. In 1966, he developed the Efficient Markets Hypothesis, which asserts that current securities prices reflect all available information and expectations.
This framework has several implications for investors. If current market prices offer the best available estimate of real value, stock mispricing should be considered a rare condition that cannot be systematically exploited through fundamental research or market timing. Moreover, only unanticipated future events will trigger price changes, which is one reason for the apparent short-term “randomness” of returns.
The hypothesis states that investors may be best served through passive, structured portfolios. Rather than trying to out-research other players in the market, a passive investor looks to asset class diversification to manage uncertainty and position for long-term growth in the capital markets.