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Efficient Capital Markets
• Prices in informationally efficient capital
markets reflect all available information.
• To outperform the market, we need to find
and exploit inefficiencies.
CFALA/USC CFA Review Level 1, SS-13
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The Efficient Markets Paradox
If prices were truly efficient, no one could profit
from research so none would be done.
If no one traded on research, prices would not be
efficient.
CFALA/USC CFA Review Level 1, SS-13
Resolution of the Paradox
• Prices are not always fully efficient.
• Informed traders profit when securities are
mispriced.
• Securities are mispriced when
 Values change
 Uninformed traders cause prices to change.
• Informed traders profit to the extent of their
informational advantage.
CFALA/USC CFA Review Level 1, SS-13
a. define an efficient capital market and describe and contrast the three forms of the efficient
market hypothesis (EMH);
Efficient Capital Markets
• An efficient capital market is one in which
security prices adjust rapidly to the arrival
of new information so that current securities
prices of securities reflect all available
information.
 New information is unexpected information.
CFALA/USC CFA Review Level 1, SS-13
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Who Makes Markets Efficient?
• Speculators compete to profit from unique
information and analytic insights into
security values.
• Well informed traders buy when prices are
below fundamental value. Their buying
pushes prices toward fundamental value.
 Likewise for selling.
CFALA/USC CFA Review Level 1, SS-13
The Efficient Markets Hypothesis
Prices reflect all available information about
security values.
Three forms of the EMH condition on
different sets of available information.
CFALA/USC CFA Review Level 1, SS-13
… describe and contrast the forms of the efficient market hypothesis (EMH)…
The Three Forms of the EMH
• Weak: market information, such at historical
sequence of prices, trading volume, odd-lot
transactions, etc.
• Semi Strong: all public information including
public information about earnings, new products,
political conditions, and market conditions.
• Strong: all public and private information. Private
information includes insider information and
privately acquired data and analyses.
CFALA/USC CFA Review Level 1, SS-13
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Market Efficiency
Semi-Strong Form
All Public Information
Public and Private
Weak Form
Security Market
Information
CFALA/USC CFA Review Level 1, SS-13
… describe and contrast the forms of the efficient market hypothesis (EMH)…
The Three Forms of the EMH
Here’s how I remember it:
• If Weak form is true:
 Technical traders/chartists can’t win.
• If Semi Strong form is true:
 CFAs can’t win.
• If Strong form is true:
 Illegal insider traders can’t win.
CFALA/USC CFA Review Level 1, SS-13
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