The Efficient Market Theory and Evidence: Implications for Active Investment Management
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
Stephen M. Schaefer
London Business School - Institute of Finance and Accounting
February, 29 2012
Foundations and Trends in Finance, Vol. 5, No. 3, 2010
The Efficient Market Hypothesis (EMH) asserts that, at all times, the price of a security reflects all available information about its fundamental value. The implication of the EMH for investors is that, to the extent that speculative trading is costly, speculation must be a loser’s game. Hence, under the EMH, a passive strategy is bound eventually to beat a strategy that uses active management, where active management is characterized as trading that seeks to exploit mispriced assets relative to a risk-adjusted benchmark. The EMH has been refined over the past several decades to reflect the realism of the marketplace, including costly information, transactions costs, financing, agency costs, and other real-world frictions. The most recent expressions of the EMH thus allow a role for arbitrageurs in the market who may profit from their comparative advantages. These advantages may include specialized knowledge, lower trading costs, low management fees or agency costs, and a financing structure that allows the arbitrageur to undertake trades with long verification periods. The actions of these arbitrageurs cause liquid securities markets to be generally fairly efficient with respect to information, despite some notable anomalies.
Number of Pages in PDF File: 99
Keywords: efficient market hypothesis, CAPM, APT, arbitrage
JEL Classification: G10 General Financial Markets, G14 Information and Market EfficiencyAccepted Paper Series
Date posted: February 29, 2012
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