Efficient Markets, Theory of

The theory of efficient markets postulates that in a well-functioning capital market the best estimate of the value of a financial security is today’s price. This relationship holds because the current price of an asset reflects all the information available to buyers. According to the efficient markets hypothesis (EMH), stock prices only change when new information becomes available or when discount rates change. In defense of the theory, EMH advocates point out the so-called random walks of stocks and (more generally) securities through time—that is, price changes are unpredictable because prices only respond to new information (and the newness of information, by definition, makes it unpredictable). In case of investor disagreements about the value of a security, share price valuations will, at least approximately, converge ...

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