Efficient Market Hypothesis Rationale 1. There is a large number of profit-maximizing investors working independently in the analysis and valuation of securities. 2. New information about securities reaches the market in a random fashion, is readily available, and is costless. 3. Transaction costs are small. 4. Investors adjust prices of securities rapidly in response to this new, randomly arriving information. 5. The current price of a security is a fair price, fully reflecting the risk associated with the security. The Random Walk Theory 1. Future events are random and unpredictable. 2. The best estimate of next period's value is simply this period's value. Implications Security prices are determined in a logical, rational fashion, and in the long run should be expected to rise steadily. But price changes are random. It is not possible to derive trading systems or investment strategies based on current information that will produce returns greater than that expected on the basis of the risk of the security. It is very difficult to consistently “beat the market” on a risk-adjusted basis.
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