Efficient Markets,
Random Walks, and Bubbles
The theory that financial markets are very efficient, and the extensive research investigating this theory, form the leading intellectual basis for arguments against the idea that markets are vulnerable to excessive exuberance or bubbles. The efficient markets theory asserts that all financial prices accurately reflect all public information at all times. In other words, financial assets are always priced correctly, given what is publicly known, at all times. Price may appear to be too high or too low at times, but, according to the efficient markets theory, this appearance must be an illusion.
Stock prices, by this theory, approximately describe “random walks” through time: the price changes are unpredictable since they occur only in response to genuinely new information, which by the very fact that is new is unpredictable. The efficient markets theory and the random walk hypothesis have been subjected to many tests using data on stock markets, in studies published in scholarly journals of finance and economics. Although the theory has been statistically rejected many times in these publications, by some interpretations it may nevertheless be described as approximately true. The literature on the evidence for this theory is well developed
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