finance
The Efficient Market Hypothesis (EMH) originates from empirical research indicating that asset prices adhere to a random walk. Notable early studies conducted by Louis Bachelier, Holbrook Working, Alfred Cowles, and Maurice G. Kendall demonstrated a lack of correlation between consecutive price changes. This finding suggested that markets do not exhibit predictable patterns.
The concept of EMH was further developed by Paul A. Samuelson and Benoit Mandelbrot in the mid-20th century. They argued that if markets function correctly, all available public (and, in some interpretations, private) information is promptly reflected in asset prices. According to this view, price fluctuations appear random because investors have already capitalized on all arbitrage opportunities.
Eugene Fama significantly popularized the EMH in 1970, linking it to the rational expectations hypothesis prevalent in macroeconomics. The EMH posed challenges for technical traders and chartists, who believed they could predict price movements based on historical patterns. Additionally, while the hypothesis primarily focuses on the significance of information and beliefs in ensuring market efficiency, it acknowledges potential speculative bubbles fueled by misinformation or crowd behavior, without addressing other economic efficiencies such as resource allocation.
The second critical aspect of financial research pertains to the empirical analysis of asset prices. A troubling discovery emerged: asset prices displayed characteristics of a random walk. The foundational work by researchers, including Louis Bachelier (1900) on commodity prices and later confirmations by Holbrook Working (1934), Alfred Cowles (1933, 1937) on American stock prices, and Maurice G. Kendall (1953) regarding British stock and commodity prices, consistently suggested a lack of correlation in consecutive price changes.
The pivotal breakthrough came through Samuelson in 1965 and Mandelbrot in 1966. They interpreted the findings of Working, Cowles, and Kendall not as an indication that financial markets operated outside economic laws, but rather that they function too effectively. Their core argument was straightforward: if price changes were predictable, profit-driven arbitrageurs would exploit those trends to their advantage. Therefore, they presented the EMH premise: when markets operate optimally, all pertinent information regarding an asset is quickly integrated into its market price.
It is crucial to note that the term "efficient" in this context refers only to the use of information by market participants; it does not encapsulate other forms of economic efficiency, such as resource allocation in production.
The EMH gained notable traction through Eugene Fama's work but also led to dissatisfaction among certain practitioners. Technical traders or chartists, seeking to forecast asset prices through the analysis of price movement patterns, found themselves challenged by the EMH, which asserts that they cannot "beat the market" as all information is already priced in. Furthermore, the EMH's foundation in "information" and "beliefs" does not preclude the potential for speculative bubbles, which can arise from rumors, misinformation, and collective market behavior.
In conclusion, while the EMH provides critical insights into market behavior and efficiency, it also opens discussions regarding its limitations, particularly around the influence of speculative dynamics on financial markets.