gen-define-the-efficient-market-hypothesis-and-give-one-short-wo-a16c

Define the efficient market hypothesis and give one short worked example.

# Efficient Market Hypothesis (EMH) ## Definition The **Efficient Market Hypothesis** states that asset prices fully reflect all available information at any given time. This means it's impossible to consistently "beat the market" through stock picking or market timing, because any new information is rapidly incorporated into prices. There are three forms: - **Weak form**: Prices reflect all past trading information - **Semi-strong form**: Prices reflect all publicly available information - **Strong form**: Prices reflect all information, including insider information ## Worked Example **Scenario**: A pharmaceutical company is trading at $50 per share. **Event**: On Monday at 9:00 AM, the company announces FDA approval for a breakthrough drug expected to double revenues. **EMH Prediction**: - 9:01 AM: Traders immediately buy shares - 9:05 AM: Stock price jumps to $75 - 9:10 AM: Price stabilizes at $73 after initial overreaction **Key Point**: By 9:15 AM, the "new fair value" of $73 already incorporates all known information about the FDA approval. An investor reading the news at 10:00 AM cannot profit from it—the opportunity is gone. The price adjusted almost instantly, making it impossible to earn abnormal returns from this public information. This demonstrates semi-strong form efficiency: publicly available information is rapidly reflected in prices.