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Efficient Market Hypothesis

  1. Stephen F. LeRoy

Published Online: 15 MAY 2010

DOI: 10.1002/9780470061602.eqf03004

Encyclopedia of Quantitative Finance

Encyclopedia of Quantitative Finance

How to Cite

LeRoy, S. F. 2010. Efficient Market Hypothesis. Encyclopedia of Quantitative Finance. .

Author Information

  1. University of Melbourne, Victoria and University of Adelaide, South Australia, Australia

Publication History

  1. Published Online: 15 MAY 2010

Abstract

Despite the fact that the topic of capital market efficiency plays a central role in introductory instruction in finance, it is difficult to determine exactly what it means. Fama's well-known statement that market efficiency can be tested only jointly with an assumed returns model implies that market efficiency generates restrictions on the data that are distinct from those implied by particular models. It is difficult to find a clear characterization of what these additional restrictions are. One possibility is that the proponents of this theory identified market efficiency with rational expectations. Another possibility (suggested by empirical tests of efficiency) is that an efficient market is one in which expected returns are constant. A third possibility is that an efficient market is one in which asset prices are similar to those that would occur in the absence of frictions. All of these interpretations have difficulties. It is concluded that distinguishing market efficiency from particular returns models is a questionable research strategy.

Keywords:

  • market efficiency;
  • constant returns model;
  • risk neutrality;
  • price volatility;
  • rational expectations;
  • trading frictions;
  • short sales