Are the Sharemarkets "Efficient?"
Or are there opportunities for reasoned investors?
Efficient Market Hypothesis is a common view of how share markets work that has dominated investing for the last 30+ years.
The Efficient Market Hypothesis asserts that prices of financial assets - stocks, bonds and property - already reflect all known information and are therefore unbiased because, based on this information, all investors believe the same thing about future prospects. Success in the share market is only influenced by luck, because everyone has full information, and everyone in the market knows this information, so there are no undervalued products that can be bought cheaply for long term gain. This is the Efficient Market Hypothesis, used to assess portfolio risk.
Read more in Lo, Andrew W. "Efficient Markets Hypothesis." The New Palgrave Dictionary of Economics
Efficient Market Hypothesis is not the Efficient Frontier
The Efficient Market Hypothesis should not to be confused with the Archimedes Efficient Frontier portfolio risk assessment methodology.
The Efficient Market Hypothesis, if true, means investors will not find undervalued products because all products are fairly valued at all times. If this is true, there is no need for research or good advice!
However, there are many people (including us at Archimedes Financial Planning) who have severe reservations of the Efficient Market Hypothesis and the associated Modern Portfolio Theory as a means of assessing the risk level of your portfolio.
Some thought-provoking reading material covering whether the markets are efficient include:
- Why economic theory is out of whack" (pdf 180 kb) Mark Buchanan, New Scientist
- “The (mis)behavior of markets” by Benoit Mandelbrot and Richard Hudson
- “Fooled by Randomness” Nassim Taleb (second edition).
Archimedes Financial Planning is skeptical of the Efficient Market Hypothesis. We believe under-valued products can be found, especially when Behavioural Finance techniques are understood.
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