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IAI Actuarial Core Principles · Economic Modelling · Rational expectations theory and the efficient markets hypothesis

Which of the following is an essential implication of a market that is efficient in the sense of the EMH?

Investors cannot consistently earn risk-adjusted abnormal returns using the relevant information set. Prices already reflect that information and move only on new, unpredictable news, though prices still change and expected returns still vary with risk.

  1. AShare prices never change
  2. BPrice changes are predictable from past price patterns
  3. CInvestors cannot consistently earn returns above those justified by risk using the relevant information setCorrect
  4. DEvery investor earns the same return in every period
  5. All shares have the same expected return regardless of risk

Explanation

Efficiency means prices reflect the relevant information, so new information moves prices unpredictably and no one can consistently earn abnormal (risk-adjusted) returns using that information. Prices still change as news arrives, and expected returns still differ with risk, so the other statements misstate the hypothesis.

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