Market Efficiency Defined

Financial market movements may not always appear rational however at any given time it is most likely that the current price of securities correctly reflects all available information and expectations.

• Market prices are the best approximation of intrinsic value
• Price changes are random due to unforeseen events
• Mis-pricings do occur but not in predictable patterns making it difficult to recognize them

Merton Miller won a Nobel Prize for developing the concept that the market is a very efficient pricing mechanism.  He believed that the financial markets are such an efficient pricing mechanism that it adjusts for all new Information coming into it very rapidly. Since the market is such an amazingly efficient device for processing new bits of information investors should consider being passive in their approach. Passive approaches, by implication, mean being fully invested in a low turnover strategy.

If new information is revealed about a firm it will be incorporated into the share price rapidly and rationally; no trader will be presented with an opportunity for making a return on a share or other security that is greater than a fair return for the riskiness associated with that share or other security.