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Explain the theory of efficient markets including opposing criticisms.

Explain the theory of efficient markets including opposing criticisms.

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Answer #1

The efficient market hypothesis holds that when new information comes into the market, it is immediately reflected in stock prices. It states that asset prices fully reflect all available information. It was developed because shares are always traded at fairs prices, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices.The criticisms of this is:

  • People getting carried away by booms and asset bubbles.
  • The second is behavioral finance, which maintains that investors are guided by psychology more than by rationality and efficiency.
  • Third is fundamental analysis, which holds that certain valuation ratios predict out performance and under performance in future periods.
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