---
date: '2025-09-08'
description: how prices reflect information, and why tests of efficiency also test a model of expected returns
id: efficient market hypothesis
modified: 2026-06-05 15:08:26 GMT-04:00
tags:
  - seed
  - finance
title: efficient market hypothesis
created: '2025-09-08'
published: '2025-09-08'
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slug: thoughts/efficient-market-hypothesis
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---
The efficient market hypothesis states that security prices fully reflect a specified information set. Fama distinguishes three forms \[@fama1970efficient\].

| form        | information reflected in prices |
| ----------- | ------------------------------- |
| weak        | past prices and returns         |
| semi-strong | publicly available information  |
| strong      | public and private information  |

The strong form includes information held by insiders, so it makes a stronger claim than the public-information version.

An investor can earn a positive return in an efficient market. The empirical question is whether a strategy earns more than the return required for its risk, after the costs of obtaining information and trading. A higher return by itself does not answer that question.

To measure an abnormal return, we must first choose a model of the return that should have been expected. A failed test can therefore reflect mispricing or a bad expected-return model. Fama calls this the joint-hypothesis problem. His 1991 review also makes information and transaction costs explicit \[@fama1991efficient\].

The shorthand “consistent alpha is impossible” needs qualification. Alpha is measured against a model, and a claim about exploitable information depends on who can obtain it and at what cost.