What does the EMH have to say about abnormal returns?

The efficient market hypothesis (EMH) is a theory in finance that states that financial markets are efficient, meaning that prices reflect all available information and any deviations from the expected return are likely to be corrected quickly. The EMH has implications for the ability to earn abnormal returns, or excess returns, in financial markets.

According to the EMH, it is difficult to earn abnormal returns by simply buying undervalued assets or selling overvalued assets, as the market will tend to adjust to reflect the true value of the asset.

This is because, in an efficient market, prices are expected to fully reflect all available information, including the intrinsic value of the asset. As a result, it is difficult to identify mispriced assets or opportunities to earn abnormal returns.

However, the EMH does not necessarily mean that it is impossible to earn abnormal returns in financial markets. While the EMH suggests that it is difficult to earn abnormal returns through simple strategies such as buying undervalued assets or selling overvalued assets, it does not rule out the possibility of earning abnormal returns through more sophisticated strategies.

For example, some investors may be able to earn abnormal returns by using specialized knowledge or expertise to identify mispriced assets or opportunities that are not reflected in the market. Others may be able to earn abnormal returns by taking on additional risk, such as investing in less liquid or less well-known assets.

Overall, the EMH suggests that it is difficult to earn abnormal returns in financial markets, but it does not rule out the possibility of earning abnormal returns through more sophisticated strategies or by taking on additional risk.

While the EMH is a widely accepted theory in finance, it has been the subject of much debate and has been challenged by some researchers who have found evidence of persistent patterns in financial markets that are not consistent with the EMH.

Leave a Comment