Financial Management · Efficient market hypothesis (EMH) and practical considerations in the valuation of shares

Evidence For and Against Market Efficiency in ACCA FM

Updated 11 October 2026 · Fact-checked

Evidence on market efficiency comes from tests of whether prices react quickly to news and whether past data or public information can beat the market. Most evidence supports weak and semi-strong form efficiency. Anomalies and behavioural finance challenge it. You must state evidence, link it to the form tested, and give a balanced conclusion.

Understand Evidence for and Against Market Efficiency

The efficient market hypothesis (EMH) says share prices fully and quickly reflect available information. If so, you cannot consistently earn abnormal returns using that information. The three forms are weak (past prices), semi-strong (all public information) and strong (public and private information).

Researchers test this in three main ways. Tests of weak form look for patterns in past prices, such as whether yesterday's change predicts tomorrow's. Studies generally find little predictable pattern, so technical analysis (chartism) is hard to profit from. This supports weak form efficiency.

Event studies test semi-strong form. You pick an event, such as a results announcement, takeover bid or dividend change. You compare actual share returns around the announcement with the returns expected from the market. If the abnormal return appears at once on announcement and then stops, the market reacted quickly. If prices keep drifting, the market was slow. Evidence generally shows quick reaction to public news. Studies of fund managers also help: if professional managers with research cannot consistently beat the market after costs, that supports efficiency. Tests of strong form often look at insider dealing. Insiders do appear to earn abnormal gains, so strong form generally does not hold.

Anomalies are patterns that seem to contradict the EMH. Examples are the January effect (higher returns early in the year), the small firm effect (small companies earning higher returns than size would suggest), the day-of-the-week effect, and overreaction to news followed by reversal. Supporters of the EMH reply that some anomalies may disappear once found, may vanish after transaction costs, or may reflect risk the models miss.

Behavioural finance argues that investors are not always rational. Examples are overconfidence, herd behaviour, loss aversion and anchoring. It is used to explain bubbles and crashes, such as prices moving far from fundamental value. The counter-argument is that irrational behaviour may be random and cancel out, and that behavioural theories explain events afterwards but do not give a reliable way to profit.

Key rules to remember

Abnormal return: Abnormal return = Actual return − Expected return; Expected return is usually based on the market return and the share's beta. Used in event studies.
Weak form: Prices reflect all past price and trading information; If true, technical analysis cannot give consistent abnormal returns.
Semi-strong form: Prices reflect all publicly available information; If true, fundamental analysis of public data cannot give consistent abnormal returns.
Strong form: Prices reflect all information, public and private; If true, even insiders cannot make abnormal gains. Evidence generally rejects this.

How to solve Evidence for and Against Market Efficiency questions

Use this method for any written or objective question on evidence about efficiency.

1Identify which form of the EMH the question tests: weak, semi-strong or strong.
2Match the evidence to the form. Price patterns link to weak, announcements and public news to semi-strong, insider gains to strong.
3State what the evidence shows: does it support or challenge the form?
4If an anomaly is given, name it and say why it challenges the EMH.
5Give the counter-argument, for example transaction costs, risk not captured, or the anomaly disappearing once known.
6Where behavioural factors are mentioned, name the bias and explain how it moves price away from fundamental value.
7Finish with a short balanced conclusion and, if asked, the implication for managers or investors.

Quickest way: Match the evidence to the form

When to use it: Use this for Section A and Section B objective questions, where you must pick the single correct statement.

Look for the key words: past prices, public announcement, or insider information.
Past prices point to weak form. Announcements and news point to semi-strong. Insiders point to strong.
Fast reaction and no later drift supports efficiency. Slow reaction or drift challenges it.
Calendar patterns and size effects are anomalies, which challenge the EMH.
Herding, overconfidence and bubbles are behavioural finance points.
Cross out statements using always, never or proves, as evidence rarely proves anything fully.

Common mistakes in Evidence for and Against Market Efficiency

Saying anomalies prove the market is inefficient.
Students treat a pattern as conclusive.
Fix: Say anomalies challenge the EMH, but may reflect risk, costs or chance, and may disappear once widely known.
Linking event studies to weak form.
Students mix up price history with announcements.
Fix: Event studies test reaction to public news, so they test semi-strong form.
Claiming insider gains show the market is not semi-strong efficient.
Students confuse public and private information.
Fix: Insider gains use private information, so they show strong form does not hold. They do not contradict semi-strong form.
Describing behavioural finance as proof that investors are always irrational.
Overstating the theory.
Fix: Say it argues some investors act irrationally in systematic ways, which can push prices from fundamental value.
Giving a one-sided answer when asked to discuss.
Students list only evidence for or only against.
Fix: Give both sides and end with a conclusion, for example that markets are broadly efficient in weak and semi-strong forms but with exceptions.

Worked examples

Example 1

A company announces unexpectedly high profits. Its share price jumps on the day of the announcement and then stays level over the following weeks. Which form of the EMH does this support, and why?

Show the solution

The event is a public announcement, so the test relates to semi-strong form.
The price adjusted on the day of the news.
There was no further drift afterwards, so the information was fully reflected quickly.
This is consistent with semi-strong form efficiency.

Answer: It supports semi-strong form efficiency, because the price reacted quickly to public information and did not continue to move afterwards.

Example 2

Discuss, in about five points, whether the January effect and the small firm effect show that share markets are inefficient.

Show the solution

Define: the January effect is higher average returns early in the year. The small firm effect is higher returns on small companies than expected.
Both appear to allow abnormal returns from a simple rule using public information, so they challenge semi-strong and even weak form efficiency.
Counter-argument: higher small firm returns may compensate for extra risk, lower liquidity or higher transaction costs.
Counter-argument: once an anomaly is known, investors trade on it and it may weaken or vanish. Patterns may also arise by chance in the data.
Behavioural finance may explain some patterns, for example tax-related selling or herd behaviour, which suggests some investors are not fully rational.
Conclusion: the anomalies challenge the EMH but do not conclusively disprove it, as profits are hard to earn consistently after costs and risk.

Answer: The anomalies challenge market efficiency but do not prove inefficiency. They may reflect risk, costs or chance, and may fade once known, so the evidence is mixed and markets are broadly efficient with exceptions.

Exam tips

Always state which form of the EMH the evidence relates to. This is often the key mark.
In discussion questions, give evidence for and against, then a conclusion. A one-sided answer loses marks.
Know three or four anomalies by name, and one counter-argument for each.
In objective questions, avoid options that say the evidence proves or disproves the EMH completely.
Link to practice where you can: if markets are efficient, managers cannot time issues and should focus on positive NPV projects.

Practice questions from Efficient market hypothesis (EMH) and practical considerations in the valuation of shares

Evidence for and Against Market Efficiency in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Actuarial Core Principles (IAI)Testing Market Efficiency and Empirical Evidence

Evidence for and Against Market Efficiency: frequently asked questions

What is the main evidence supporting the efficient market hypothesis?

Studies find little predictable pattern in past prices, which supports weak form. Event studies show prices react quickly to public news, which supports semi-strong form. Professional fund managers also struggle to beat the market consistently after costs.

What are market anomalies?

They are patterns in returns that appear to contradict the EMH, such as the January effect, the small firm effect and the day-of-the-week effect. They may be explained by risk, costs or chance, and may weaken once investors know about them.

How does an event study test market efficiency?

It compares actual share returns around an event, such as a results announcement, with the returns expected from the market. If the abnormal return occurs immediately and then stops, the market is reacting efficiently to public information.

How does behavioural finance challenge the EMH?

It argues that investors can be overconfident, follow the herd or fear losses too much. These biases can push prices away from fundamental value, which may help explain bubbles and crashes. Critics say such effects may cancel out and are hard to use for consistent profit.