Efficient-market hypothesis

The efficient-market hypothesis (EMH)^[a] is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information.

Because the EMH is formulated in terms of risk adjustment, it only makes testable predictions when coupled with a particular model of risk.^[2] As a result, research in financial economics since at least the 1990s has focused on market anomalies, that is, deviations from specific models of risk.^[3]

The idea that financial market returns are difficult to predict goes back to Bachelier,^[4] Mandelbrot,^[5] and Samuelson,^[6] but is closely associated with Eugene Fama, in part due to his influential 1970 review of the theoretical and empirical research.^[2] The EMH provides the basic logic for modern risk-based theories of asset prices, and frameworks such as consumption-based asset pricing and intermediary asset pricing can be thought of as the combination of a model of risk with the EMH.^[7]

Many decades of empirical research on return predictability has found mixed evidence. Research in the 1950s and 1960s often found a lack of predictability (e.g. Ball and Brown 1968; Fama, Fisher, Jensen, and Roll 1969), yet the 1980s-2000s saw an explosion of discovered return predictors (e.g. Rosenberg, Reid, and Lanstein 1985; Campbell and Shiller 1988; Jegadeesh and Titman 1993). Since the 2010s, studies have often found that return predictability has become more elusive, as predictability fails to work out-of-sample (Goyal and Welch 2008), or has been weakened by advances in trading technology and investor learning (Chordia, Subrahmanyam, and Tong 2014; McLean and Pontiff 2016; Martineau 2021).

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