Skip to main content
SpringerLink
Log in

Efficient Markets Hypothesis

  • Reference work entry
  • First Online:
The New Palgrave Dictionary of Economics

  • 541 Accesses

Abstract

The efficient markets hypothesis (EMH) maintains that market prices fully reflect all available information. Developed independently by Paul A. Samuelson and Eugene F. Fama in the 1960s, this idea has been applied extensively to theoretical models and empirical studies of financial securities prices, generating considerable controversy as well as fundamental insights into the price-discovery process. The most enduring critique comes from psychologists and behavioural economists who argue that the EMH is based on counterfactual assumptions regarding human behaviour, that is, rationality. Recent advances in evolutionary psychology and the cognitive neurosciences may be able to reconcile the EMH with behavioural anomalies.

This is a preview of subscription content, log in via an institution to check access.

Access this chapter

Log in via an institution
Chapter
USD 29.95
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
eBook
USD 6,499.99
Price excludes VAT (USA)
  • Available as EPUB and PDF
  • Read on any device
  • Instant download
  • Own it forever
Hardcover Book
USD 8,499.99
Price excludes VAT (USA)
  • Durable hardcover edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Purchases are for personal use only

Institutional subscriptions

Bibliography

  • Anderson, P., K. Arrow, and D. Pines, eds. 1988. The economy as an evolving complex system. Reading: Addison-Wesley Publishing Company.

    Google Scholar 

  • Arthur, B., J. Holland, B. LeBaron, R. Palmer, and P. Tayler. 1997. Asset pricing under endogenous expectations in an artificial stock market. In The economy as an evolving complex system II, ed. B. Arthur, S. Durlauf, and D. Lane. Reading: Addison Wesley.

    Google Scholar 

  • Ball, R., and P. Brown. 1968. An empirical evaluation of accounting income numbers. Journal of Accounting Research 6: 159–178.

    Article  Google Scholar 

  • Banz, R. 1981. The relationship between return and market value of common stock. Journal of Financial Economics 9: 3–18.

    Article  Google Scholar 

  • Barber, B., and T. Odean. 2001. Boys will be boys: gender, overconfidence, and common stock investment. Quarterly Journal of Economics 116: 261–229.

    Article  Google Scholar 

  • Barkow, J., L. Cosmides, and J. Tooby. 1992. The adapted mind: Evolutionary psychology and the generation of culture. Oxford: Oxford University Press.

    Google Scholar 

  • Basu, S. 1977. The investment performance of common stocks in relation to their price–earnings ratios: A test of the efficient market hypothesis. Journal of Finance 32: 663–682.

    Article  Google Scholar 

  • Becker, G. 1976. Altruism, egoism, and genetic fitness: Economics and sociobiology. Journal of Economic Literature 14: 817–826.

    Google Scholar 

  • Bell, D. 1982. Risk premiums for decision regret. Management Science 29: 1156–1166.

    Article  Google Scholar 

  • Bernard, V., and J. Thomas. 1990. Evidence that stock prices do not fully reflect the implications of current earnings for future earnings. Journal of Accounting and Economics 13: 305–340.

    Article  Google Scholar 

  • Bernstein, P. 1998. Why the efficient market offers hope to active management. In Economics and portfolio strategy. New York: Peter Bernstein, Inc, October 1.

    Google Scholar 

  • Black, F. 1986. Noise. Journal of Finance 41: 529–544.

    Article  Google Scholar 

  • Black, F., and M. Scholes. 1973. Pricing of options and corporate liabilities. Journal of Political Economy 81: 637–654.

    Article  Google Scholar 

  • Brown, S., W. Goetzmann, R. Ibbotson, and S. Ross. 1992. Survivorship bias in performance studies. Review of Financial Studies 5: 553–580.

    Article  Google Scholar 

  • Campbell, J., and R. Shiller. 1988. The dividend–price ratio and expectations of future dividends and discount factors. Review of Financial Studies 1: 195–228.

    Article  Google Scholar 

  • Chan, K. 1988. On the contrarian investment strategy. Journal of Business 61: 147–164.

    Article  Google Scholar 

  • Chan, L., N. Jegadeesh, and J. Lakonishok. 1996. Momentum strategies. Journal of Finance 51: 1681–1713.

    Article  Google Scholar 

  • Chan, N., B. LeBaron, A. Lo, and T. Poggio. 1998. Information dissemination and aggregation in asset markets with simple intelligent traders, Laboratory Technical Memorandum No. 1646. Cambridge, MA: MIT Artificial Intelligence.

    Google Scholar 

  • Chopra, N., J. Lakonishok, and J. Ritter. 1992. Measuring abnormal performance: Do stocks overreact? Journal of Financial Economics 31: 235–286.

    Article  Google Scholar 

  • Cootner, P. 1962. Stock prices: Random vs. systematic changes. Industrial Management Review 3: 24–45.

    Google Scholar 

  • Cootner, P. 1964. The random character of stock market prices. London: Risk Publications.

    Google Scholar 

  • Copeland, T., and D. Mayers. 1982. The value line enigma (1965–1978): A case study of performance evaluation issues. Journal of Financial Economics 10: 289–322.

    Article  Google Scholar 

  • Cowles, A. 1960. A revision of previous conclusions regarding stock price behavior. Econometrica 28: 909–915.

    Article  Google Scholar 

  • Cowles, A., and H. Jones. 1937. Some a posteriori probabilities in stock market action. Econometrica 5: 280–294.

    Article  Google Scholar 

  • Damasio, A. 1994. Descartes’ error: Emotion, reason, and the human brain. New York: Avon Books.

    Google Scholar 

  • Dawkins, R. 1976. The selfish gene. Oxford: Oxford University Press.

    Google Scholar 

  • de Finetti, B. 1937. La Prévision: Ses Lois Logiques, Ses Sources Subjectives. Annales de l’Institut Henri Poincaré 7: 1–68. English translation In Studies in subjective probability, ed. H. Kyburg and H. Smokler. New York: Wiley, 1964.

    Google Scholar 

  • DeBondt, W., and R. Thaler. 1985. Does the stock market overreact? Journal of Finance 40: 793–807.

    Article  Google Scholar 

  • Eldredge, N., and S. Gould. 1972. Punctuated equilibria: An alternative to phyletic gradualism. In Models in paleobiology, ed. T. Schopf. San Francisco: Freeman/Cooper.

    Google Scholar 

  • Elster, J. 1998. Emotions and economic theory. Journal of Economic Literature 36: 47–74.

    Google Scholar 

  • Fama, E. 1963. Mandelbrot and the stable paretian hypothesis. Journal of Business 36: 420–429.

    Article  Google Scholar 

  • Fama, E. 1965a. The behavior of stock market prices. Journal of Business 38: 34–105.

    Article  Google Scholar 

  • Fama, E. 1965b. Random walks in stock market prices. Financial Analysts Journal 21: 55–59.

    Article  Google Scholar 

  • Fama, E. 1970. Efficient capital markets: A review of theory and empirical work. Journal of Finance 25: 383–417.

    Article  Google Scholar 

  • Fama, E., and M. Blume. 1966. Filter rules and stock market trading profits. Journal of Business 39: 226–241.

    Article  Google Scholar 

  • Fama, E., and K. French. 1988. Permanent and temporary components of stock prices. Journal of Political Economy 96: 246–273.

    Article  Google Scholar 

  • Farmer, D. 2002. Market force, ecology and evolution. Industrial and Corporate Change 11: 895–953.

    Article  Google Scholar 

  • Farmer, D., and A. Lo. 1999. Frontiers of finance: Evolution and efficient markets. Proceedings of the National Academy of Sciences 96: 9991–9992.

    Article  Google Scholar 

  • Fischoff, B., and P. Slovic. 1980. A little learning…: Confidence in multicue judgment tasks. In Attention and performance, VIII, ed. R. Nickerson. Hillsdale: Erlbaum.

    Google Scholar 

  • Flavin, M. 1983. Excess volatility in the financial markets: A reassessment of the empirical evidence. Journal of Political Economy 91: 929–956.

    Article  Google Scholar 

  • French, K., and R. Roll. 1986. Stock return variances: The arrival of information and the reaction of traders. Journal of Financial Economics 17: 5–26.

    Article  Google Scholar 

  • Friedman, D. 1991. Evolutionary games in economics. Econometrica 59: 637–666.

    Article  Google Scholar 

  • Gervais, S., and T. Odean. 2001. Learning to be overconfident. Review of Financial Studies 14: 1–27.

    Article  Google Scholar 

  • Gigerenzer, G. 2000. Adaptive thinking: rationality in the real world. Oxford: Oxford University Press.

    Google Scholar 

  • Gigerenzer, G., and R. Selten. 2001. Bounded rational: The adaptive toolbox. Cambridge, MA: MIT Press.

    Google Scholar 

  • Gilles, C., and S. LeRoy. 1991. Econometric aspects of the variance-bounds tests: A survey. Review of Financial Studies 4: 753–792.

    Article  Google Scholar 

  • Grossberg, S., and W. Gutowski. 1987. Neural dynamics of decision making under risk: Affective balance and cognitive-emotional interactions. Psychological Review 94: 300–318.

    Article  Google Scholar 

  • Grossman, S., and R. Shiller. 1981. The determinants of the variability of stock market prices. American Economic Review 71: 222–227.

    Google Scholar 

  • Grossman, S., and J. Stiglitz. 1980. On the impossibility of informationally efficient markets. American Economic Review 70: 393–408.

    Google Scholar 

  • Hirshleifer, J. 1977. Economics from a biological viewpoint. Journal of Law and Economics 20: 1–52.

    Article  Google Scholar 

  • Hirshleifer, D., and G. Luo. 2001. On the survival of overconfident traders in a competitive securities market. Journal of Financial Markets 4: 73–84.

    Article  Google Scholar 

  • Huberman, G., and T. Regev. 2001. Contagious speculation and a cure for cancer: A nonevent that made stock prices soar. Journal of Finance 56: 387–396.

    Article  Google Scholar 

  • Jegadeesh, N. 1990. Evidence of predictable behavior of security returns. Journal of Finance 45: 881–898.

    Article  Google Scholar 

  • Jegadeesh, N., and S. Titman. 2001. Profitability of momentum strategies: An evaluation of alternative explanations. Journal of Finance 56: 699–720.

    Article  Google Scholar 

  • Kahneman, D., and A. Tversky. 1979. Prospect theory: An analysis of decision under risk. Econometrica 47: 263–291.

    Article  Google Scholar 

  • Keim, D. 1983. Size-related anomalies and stock return seasonality: Further empirical evidence. Journal of Financial Economics 12: 13–32.

    Article  Google Scholar 

  • Kim, M., C. Nelson, and R. Startz. 1991. Mean reversion in stock prices? A reappraisal of the empirical evidence. Review of Economic Studies 58: 515–528.

    Article  Google Scholar 

  • Kindleberger, C. 1989. Manias, panics, and crashes: A history of financial crises. New York: Basic Books.

    Book  Google Scholar 

  • Kleidon, A. 1986. Variance bounds tests and stock price valuation models. Journal of Political Economy 94: 953–1001.

    Article  Google Scholar 

  • Laibson, D. 1997. Golden eggs and hyperbolic discounting. Quarterly Journal of Economics 62: 443–477.

    Article  Google Scholar 

  • Lakonishok, J., and S. Smidt. 1988. Are seasonal anomalies real? A ninety-year perspective. Review of Financial Studies 1: 403–425.

    Article  Google Scholar 

  • Lehmann, B. 1990. Fads, martingales, and market efficiency. Quarterly Journal of Economics 105: 1–28.

    Article  Google Scholar 

  • Leroy, S. 1973. Risk aversion and the martingale property of stock returns. International Economic Review 14: 436–446.

    Article  Google Scholar 

  • LeRoy, S., and R. Porter. 1981. The present value relation: Tests based on variance bounds. Econometrica 49: 555–574.

    Article  Google Scholar 

  • Lichtenstein, S., B. Fischoff, and L. Phillips. 1982. Calibration of probabilities: The state of the art to 1980. In Judgment under uncertainty: Heuristics and biases, ed. D. Kahneman, P. Slovic, and A. Tversky. Cambridge: Cambridge University Press.

    Google Scholar 

  • Lo, A. 1991. Long-term memory in stock market prices. Econometrica 59: 1279–1313.

    Article  Google Scholar 

  • Lo, A. (ed.). 1997. Market efficiency: Stock market behavior in theory and practice, 2 vols. Cheltenham: Edward Elgar Publishing Company.

    Google Scholar 

  • Lo, A. 1999. The three P’s of total risk management. Financial Analysts Journal 55: 87–129.

    Article  Google Scholar 

  • Lo, A. 2001. Risk management for hedge funds: Introduction and overview. Financial Analysts Journal 57: 16–33.

    Article  Google Scholar 

  • Lo, A. 2002. Bubble, rubble, finance in trouble? Journal of Psychology and Financial Markets 3: 76–86.

    Article  Google Scholar 

  • Lo, A. 2004. The adaptive markets hypothesis: Market efficiency from an evolutionary perspective. Journal of Portfolio Management 30: 15–29.

    Article  Google Scholar 

  • Lo, A. 2005. Reconciling efficient markets with behavioral finance: The adaptive markets hypothesis. Journal of Investment Consulting 7: 21–44.

    Google Scholar 

  • Lo, A., and C. MacKinlay. 1988. Stock market prices do not follow random walks: Evidence from a simple specification test. Review of Financial Studies 1: 41–66.

    Article  Google Scholar 

  • Lo, A., and C. MacKinlay. 1990a. An econometric analysis of nonsynchronous trading. Journal of Econometrics 45: 181–212.

    Article  Google Scholar 

  • Lo, A., and C. MacKinlay. 1990b. Data snooping biases in tests of financial asset pricing models. Review of Financial Studies 3: 431–468.

    Article  Google Scholar 

  • Lo, A., and C. MacKinlay. 1990c. When are contrarian profits due to stock market overreaction? Review of Financial Studies 3: 175–206.

    Article  Google Scholar 

  • Lo, A., and C. MacKinlay. 1999. A non-random walk down wall street. Princeton: Princeton University Press.

    Google Scholar 

  • Lo, A., and D. Repin. 2002. The psychophysiology of real-time financial risk processing. Journal of Cognitive Neuroscience 14: 323–339.

    Article  Google Scholar 

  • Loewenstein, G. 2000. Emotions in economic theory and economic behavior. American Economic Review 90: 426–432.

    Article  Google Scholar 

  • Lucas, R. 1978. Asset prices in an exchange economy. Econometrica 46: 1429–1446.

    Article  Google Scholar 

  • Luo, G. 1995. Evolution and market competition. Journal of Economic Theory 67: 223–250.

    Article  Google Scholar 

  • Markowitz, H. 1991. Foundations of portfolio theory. Journal of Finance 46: 469–477.

    Article  Google Scholar 

  • Marsh, T., and R. Merton. 1986. Dividend variability and variance bounds tests for the rationality of stock market prices. American Economic Review 76: 483–498.

    Google Scholar 

  • Maynard Smith, J. 1982. Evolution and the theory of games. Cambridge: Cambridge University Press.

    Book  Google Scholar 

  • Merton, R. 1973. Theory of rational option pricing. Bell Journal of Economics and Management Science 4: 141–183.

    Article  Google Scholar 

  • Merton, R. 1987. On the current state of the stock market rationality hypothesis. In Macroeconomics and finance: Essays in honor of Franco Modigliani, ed. R. Dornbusch, S. Fischer, and J. Bossons. Cambridge, MA: MIT Press.

    Google Scholar 

  • Michener, R. 1982. Variance bounds in a simple model of asset pricing. Journal of Political Economy 90: 166–175.

    Article  Google Scholar 

  • Nelson, R., and S. Winter. 1982. An evolutionary theory of economic change. Cambridge, MA: Belknap Press of Harvard University Press.

    Google Scholar 

  • Niederhoffer, V. 1997. Education of a speculator. New York: Wiley.

    Google Scholar 

  • Odean, T. 1998. Are investors reluctant to realize their losses? Journal of Finance 53: 1775–1798.

    Article  Google Scholar 

  • Osborne, M. 1959. Brownian motion in the stock market. Operations Research 7: 145–173.

    Article  Google Scholar 

  • Poterba, J., and L. Summers. 1988. Mean reversion in stock returns: Evidence and implications. Journal of Financial Economics 22: 27–60.

    Article  Google Scholar 

  • Ramsey, F. 1926. Truth and probability. In Foundations of mathematics and other logical essays, ed. R. Braithwaite. New York: Harcourt Brace & Co.

    Google Scholar 

  • Richardson, M. 1993. Temporary components of stock prices: A skeptic’s view. Journal of Business and Economics Statistics 11: 199–207.

    Google Scholar 

  • Roberts, H. 1959. Stock-market ‘patterns’ and financial analysis: Methodological suggestions. Journal of Finance 14: 1–10.

    Google Scholar 

  • Roberts, H. 1967. Statistical versus clinical prediction of the stock market. Unpublished manuscript, Center for Research in Security Prices, University of Chicago, Chicago.

    Google Scholar 

  • Roll, R. 1983. Vas is das? The turn-of-the-year effect and the return premia of small firms. Journal of Portfolio Management 9: 18–28.

    Article  Google Scholar 

  • Roll, R. 1984. Orange juice and weather. American Economic Review 74: 861–880.

    Google Scholar 

  • Rolls, E. 1999. The brain and emotion. Oxford: Oxford University Press.

    Google Scholar 

  • Rosenberg, B., K. Reid, and R. Lanstein. 1985. Persuasive evidence of market inefficiency. Journal of Portfolio Management 11: 9–17.

    Article  Google Scholar 

  • Rozeff, M., and W. Kinney Jr. 1976. Capital market seasonality: The case of stock returns. Journal of Financial Economics 3: 379–402.

    Article  Google Scholar 

  • Rubinstein, M. 1976. The valuation of uncertain income streams and the pricing of options. Bell Journal of Economics 7: 407–425.

    Article  Google Scholar 

  • Rubinstein, A. 1998. Modeling bounded rationality. Cambridge, MA: MIT Press.

    Google Scholar 

  • Samuelson, P. 1947. Foundations of economics analysis. Cambridge, MA: Harvard University Press.

    Google Scholar 

  • Samuelson, P. 1965. Proof that properly anticipated prices fluctuate randomly. Industrial Management Review 6: 41–49.

    Google Scholar 

  • Sargent, T. 1993. Bounded rationality in macroeconomics. Oxford: Clarendon Press.

    Google Scholar 

  • Savage, L. 1954. Foundations of statistics. New York: Wiley.

    Google Scholar 

  • Schumpeter, J. 1939. Business cycles: A theoretical, historical, and statistical analysis of the capitalist process. New York: McGraw-Hill.

    Google Scholar 

  • Shefrin, M., and M. Statman. 1985. The disposition to sell winners too early and ride losers too long: theory and evidence. Journal of Finance 40: 777–790.

    Article  Google Scholar 

  • Shiller, R. 1981. Do stock prices move too much to be justified by subsequent changes in dividends? American Economic Review 71: 421–436.

    Google Scholar 

  • Simon, H. 1955. A behavioral model of rational choice. Quarterly Journal of Economics 69: 99–118.

    Article  Google Scholar 

  • Simon, H. 1982. Models of bounded rationality, 2 vols. Cambridge, MA: MIT Press.

    Google Scholar 

  • Starmer, C. 2000. Developments in non-expected utility theory: The hunt for a descriptive theory of choice under risk. Journal of Economic Literature 38: 332–382.

    Article  Google Scholar 

  • Thaler, R., ed. 1993. Advances in behavioral finance. New York: Russell Sage Foundation.

    Google Scholar 

  • Tversky, A., and D. Kahneman. 1981. The framing of decisions and the psychology of choice. Science 211: 453–458.

    Article  Google Scholar 

  • Wilson, E. 1975. Sociobiology: The new synthesis. Cambridge, MA: Belknap Press of Harvard University Press.

    Google Scholar 

Download references

Acknowledgment

I thank John Cox, Gene Fama, Bob Merton, and Paul Samuelson for helpful discussions.

Author information

Authors and Affiliations

  1. http://link.springer.com/referencework/10.1057/978-1-349-95121-5

    Andrew W. Lo

Authors
  1. Andrew W. Lo
    View author publications

    You can also search for this author in PubMed Google Scholar

Editor information

Copyright information

© 2018 Macmillan Publishers Ltd.

About this entry

Check for updates. Verify currency and authenticity via CrossMark

Cite this entry

Lo, A.W. (2018). Efficient Markets Hypothesis. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95189-5_42

Download citation

Publish with us

Policies and ethics

Search

Navigation