The Efficient Market Hypothesis (EMH), developed by Eugene Fama of the
University of Chicago Business School in the 1960s, held sway amongst the
influential economists and finance academics till
recently. The hypothesis held that the collective wisdom of the players in the
financial markets makes the markets such an efficient information processor that all
securities in the market are always accurately priced in relation to their intrinsic
worth. The market factors all available information into security pricing to make for
infallible efficiency in the discovery of the market prices of securities and thereby
efficient allocation of capital. You cannot argue
with market prices because the market knows best. If you are trying to be a smart
investor and find low-priced stocks to beat the
markets, forget it. The market is smarter than you and has no low-priced or
high-priced stocks on offer. No investor can
consistently get higher than average market returns. If
a Warren Buffett or a whiz-kid fund manager does manage such returns, it is only a
matter of luck and not skill.
The confidence of the proponents of the efficient market theory is reflected in
a little story—a joke, of course—about George Stigler, who, with Milton
Friedman, was a high priest of the Chicago School. Someone, the story goes, was walking
with Stigler on the Chicago School campus and saw a $20 bill on
the pavement and said, "Look, George, there's a 20-dollar bill
lying here." Stigler replied, "If it were a real
20-dollar bill, it would have been picked up already," and nonchalantly walked past it.
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