The efficient market hypothesis (EMH) seems to have numerous definitions, but the general idea is that the current prices in a market (such as a stock market) reflect all available information, and that, therefore, you can’t make risk-adjusted profits in excess of the (purely theoretical) risk-free rate of return by (for example) analysing the past prices of stocks and anticipating their future movements.
The intuitive idea is this: if anyone could easily predict future prices of stocks, they would do so and attempt to profit by buying stocks that are likely to rise, and selling stocks that are likely to fall. But by doing so, such people would bid up the value of stocks that will rise, and bid down the value of stocks that will fall, moving their prices to the prices they’re predicted to have in future. So the present price should reflect the expected future price.
So if the EMH predicts that expected excess profits are impossible, it certainly predicts that guaranteed excess profits are impossible, which poses a puzzle when considered alongside this surprising guarantee. Continue reading An efficient market from different points of view