After building the pricing machinery — mean-variance optimisation, the CAPM, and the APT — we face a harder question: does that machinery describe how prices actually form? The Efficient Market Hypothesis (EMH) says yes — prices reflect all available information instantly, so no trading rule or forecast can earn risk-adjusted excess returns. The five decades of empirical work since Eugene Fama formalised the EMH in 1970 tell a more complicated story.
This topic sits at the intersection of theory, empirics, and practice. It answers:
- When and how can information be traded profitably? (EMH forms and tests)
- What patterns in prices persist despite being known? (anomalies)
- Why do anomalies exist — risk compensation or human irrationality? (behavioural finance)
- What should a stock be worth? (fundamental valuation: DDM, DCF, P/E)
Together, these lessons define what "alpha" means (any return above fair risk compensation), what sources of alpha are credible versus likely to be data-mined, and how valuation models anchor fundamental security analysis to the pricing frameworks in earlier topics.
In this lesson
- Contents
- The big picture
- How this topic connects to the rest of the unit
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