Lesson 1 of 7
The efficient market claim
Prices reflect available information. See the claim in its author's words, the three information sets it is tested against, and what each version forbids.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- The claim is that asset prices reflect available information, which is a statement about prices rather than about anyone's intelligence.
- It is usually tested against three information sets: past prices, all public information, and all information including private.
- Each version forbids a different activity, and a reader who wants to disagree has to say which one they are disagreeing with.
The efficient market claim is often described by people who want to reject it, which is the worst way to meet it. Stated by its own author it is narrow, precise, and much harder to dismiss than the caricature.
Three information sets, and what each version of the claim forbids
Hardest to defend
- All information, public and private · Forbids profiting even on information nobody else has117%
- All public information · Forbids profiting on filings, news and announcements233%
- Past prices and returns · Forbids profiting on patterns in the price history alone350%
Easiest to defend
Total6
What the claim actually says
Fama describes the origin of the idea plainly in his Nobel lecture: the central question, he writes, is whether asset prices reflect all available information, which is what he labelled the efficient markets hypothesis.
Read that carefully. It is not a claim that investors are rational, that prices are right, or that businesses are valued sensibly. It is a claim about whether information already sits in the price by the time you can act on it.
The three versions, and what each one bans
The weaker versions
- Past prices only: if this holds, no rule built from the price history alone earns an excess return.
- All public information: if this holds, nothing in a filing, an announcement or a broker note is worth acting on, because the price already contains it.
- These are the versions that most investment activity implicitly denies.
The strongest version
- All information, including private: if this held, even an insider could not profit from what only they know.
- Fama's own lecture describes the assumption that all information is costlessly available to everyone and used correctly as a strong form of market efficiency.
- Almost nobody defends this version, and the law of most countries is built on the assumption that it is false.
They are three different claims, and evidence against one is not evidence against another.
Why the claim is stronger than it sounds
The mechanism does not require most investors to be right. It requires only that enough money is available to act when a price is wrong, and that acting moves the price. One well-informed buyer with capital can correct a price that a thousand uninformed sellers created.
That is why "most people are irrational" is not an argument against efficiency, and why the useful objections in the rest of this course are all about the capital: whether it exists, whether it is allowed to act, and whether it can stay solvent long enough.
What a reader should take from it
Take the discipline of specifying. A reader who believes a company is mispriced is claiming that public information is not in the price, which is the middle version. That claim is testable and it carries a burden: you must be able to say what you know, from a public document, that the price does not appear to reflect, and why other people with more money have not already acted on it.
Most answers to that question are weak, which is the honest starting point for everything that follows.
Check yourself
What does the efficient market claim assert?
- That investors are rational
- That asset prices reflect available information
- That share prices always equal intrinsic value
Show the answer
Answer: B.
Fama's own formulation is about whether prices reflect available information, not about the psychology of the people trading.Which version does a reader deny when they claim a filing contains a mispricing nobody has acted on?
- The version about past prices only
- The version about all public information
- The strongest version, about private information
Show the answer
Answer: B.
A filing is public, so the claim is that public information is not yet in the price, which is the middle version.Why is the observation that most investors behave badly not an argument against efficiency?
- Because investors do not behave badly
- Because the claim only requires enough informed capital to act on a wrong price and move it
- Because prices are set by regulators
Show the answer
Answer: B.
Efficiency is a claim about the price, not about the average participant. A small amount of informed capital can correct what many uninformed participants create.Sources
- Fama, "Two Pillars of Asset Pricing", Prize Lecture, 8 December 2013, published 2014: the efficient markets hypothesis as the question of whether prices reflect all available information, and the description of costlessly available information used correctly as a strong form of market efficiency.
What this leaves out
- The three information sets are the standard division used in the literature. This page states them in plain words rather than quoting a taxonomy.
- Efficiency is a claim about prices reflecting information. It does not claim that prices are correct forecasts of anything.
- Nothing here settles whether any version holds. The rest of the course is about the arguments.
- None of it is advice about any security.