Debunking the myth of market efficiency

SIXTY years after it was first formulated, the core tenet of the efficient market hypothesis (EMH) – that stock prices fully reflect all available information – is still considered gospel truth in many quarters: Investors can only expect to earn a normal rate of return because prices adjust before investors can trade on fresh information.

Hypothesising about markets

Another key postulate of the EMH is investor rationality – that is, investors will automatically adjust their valuation estimates to every new piece of information.

The EMH acknowledges that individuals can independently deviate from rational behaviour. But a third assumption of the theory is that irrationally optimistic investors are just as common as irrationally pessimistic ones and thus “prices would likely rise in a manner consistent with market efficiency”, as the authors of Corporate Finance explain.