Market Efficiency—Definition, Tests, and Evidence

What is an efficient market? What does it imply for investment and valuation models? Clearly, market efficiency is a concept that is controversial and attracts strong views, pro and con, partly because of differences between individuals about what it really means, and partly because whether markets are efficient or not is a core belief that in large part determines how an investor approaches investing. This chapter provides a definition of market efficiency, considers the implications of an efficient market for investors, and summarizes some of the basic approaches that are used to test investment schemes, thereby proving or disproving market efficiency. It also provides a summary of the voluminous research on whether markets are efficient.