Lesson 1 of 7 · 14 min
What an efficient market is
In an informationally efficient market, prices absorb new information quickly and rationally, so market value sits at or near intrinsic value and nobody can earn superior risk-adjusted returns, after all costs, on a consistent basis.
In short
- An informationally efficient market is one where prices react quickly and rationally to new information, so they reflect all past and present information.
- In an efficient market, consistent superior risk-adjusted returns net of all expenses are not achievable, so a low-cost passive strategy is preferred; in an inefficient market an active strategy may win after costs.
- 'Quickly' cannot be faster than the shortest time needed to execute a trade. Efficiency is a continuum, not a yes/no label.
- Prices should react only to the unexpected (surprise) part of a news release; what was anticipated is already in the price.
- Market value is the price at which an asset can be traded now; intrinsic value is what it would be worth to investors with a complete understanding of it (often the PV of expected cash flows), and it can only be estimated.
- Efficient markets produce informative prices, which steer capital to its best uses (allocative efficiency). That is why regulators care too.
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