Study guide
9.3 Efficient Market Hypothesis
Series 65 Uniform Investment Adviser Law
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1 Introduction
About the Series 65 How to Use This Guide
2 Chapter 1: Economic Factors & Business Cycles
1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors
3 Chapter 2: Financial Reporting & Analytical Methods
2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics
4 Chapter 3: Types of Risk
3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory
5 Chapter 4: Cash Equivalents & Fixed Income Securities
4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields
6 Chapter 5: Equity Securities
5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities
7 Chapter 6: Pooled Investments
6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity
8 Chapter 7: Derivatives, Alternative Investments & Insurance Products
7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products
9 Chapter 8: Client Types & Profiles
8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer
10 Chapter 9: Portfolio Theory & Capital Markets
9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation
11 Chapter 10: Portfolio Management Strategies
10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations
12 Chapter 11: Tax Considerations & Retirement Planning
11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs
13 Chapter 12: ERISA, Special Accounts & Performance Measures
12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations
14 Chapter 13: Regulation of Investment Advisers
13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers
15 Chapter 14: Regulation of Investment Adviser Representatives
14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers
16 Chapter 15: Regulation of Broker-Dealers & Agents
15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest
17 Chapter 16: Securities Registration & Exemptions
16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions
18 Chapter 17: Communications & Client Relationships
17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations
19 Chapter 18: Ethics & Fiduciary Obligations
18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs
9.3 Efficient Market Hypothesis
Key Takeaways Explain This Topic AI
EMH states prices reflect available information.
Weak form: past prices are reflected; technical analysis adds little value.
Semi-strong form: public info reflected; fundamental analysis adds little value.
Strong form: all info reflected; not supported by evidence.
Most active managers underperform their benchmarks.
Efficient markets favor passive indexing.
Last updated: December 2025
Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis, developed by Eugene Fama in 1970, is one of the most debated theories in finance. It argues that asset prices fully reflect all available information, making it impossible to consistently "beat the market."
Core Concept
In an efficient market :
- Prices adjust rapidly and accurately to new information
- Securities are fairly priced at all times
- No investor can consistently earn risk-adjusted excess returns
- Active management cannot systematically outperform passive strategies
- The Three Forms of EMH
Each form makes progressively stronger claims about what information is reflected in prices:
Weak Form Efficiency
Claim : Prices reflect all historical market data (past prices, volume, trading patterns).
- What's Reflected Analysis That Won't Work Analysis That Might Work
- Past prices Technical analysis Fundamental analysis
- Historical volume Chart patterns Insider information
- Previous returns Momentum strategies —
Implication : Technical analysis is useless. You cannot predict future prices by studying past prices.
Semi-Strong Form Efficiency
Claim : Prices reflect all publicly available information (financial statements, news, economic data).
- What's Reflected Analysis That Won't Work Analysis That Might Work
- All public information Technical analysis Insider information
- Financial statements Fundamental analysis —
- Economic data News-based trading —
- Analyst reports — —
Implication : Neither technical NOR fundamental analysis can produce excess returns. By the time you read a financial statement or news article, the price has already adjusted.
Strong Form Efficiency
Claim : Prices reflect ALL information , including private (insider) information.
- What's Reflected Analysis That Won't Work
- All public information Technical analysis
- All private information Fundamental analysis
- Insider knowledge Insider trading
Implication : Even insiders cannot profit from their information. This form is generally NOT supported by evidence —insider trading prosecutions prove that private information has value.
Summary of EMH Forms
- Form Information Reflected Technical Analysis Fundamental Analysis Insider Trading
- Weak Past prices/volume Useless May work May work
- Semi-Strong All public info Useless Useless May work
- Strong All info (public + private) Useless Useless Useless
- Evidence For and Against EMH
- Evidence Supporting EMH
Active Manager Performance:
- Over 15 years, 88% of large-cap active managers underperform the S&P 500
- Only about 29% of active funds beat their benchmark over a decade
- Outperformance is rarely persistent—this year's winners are often next year's losers
Market Reactions:
- Stock prices adjust within minutes to earnings announcements
- Merger arbitrage opportunities disappear almost instantly
- Index inclusion effects occur immediately upon announcement
- Challenges to EMH (Market Anomalies)
- Anomaly Description Challenge to EMH
- January Effect Small stocks outperform in January Predictable pattern should not exist
- Momentum Recent winners continue winning short-term Past returns shouldn't predict future
- Value Premium Low P/B stocks outperform long-term Publicly available info shouldn't provide edge
- Small-Cap Effect Small stocks outperform large (historically) Size is public information
- Market Bubbles Prices deviate dramatically from fundamentals Prices should reflect fair value
- Behavioral Finance Critique
Behavioral finance argues that:
- Investors are not always rational
- Cognitive biases lead to systematic errors
- Markets can remain irrational longer than you can remain solvent
- Examples: Overconfidence, herding, loss aversion, anchoring
- Investment Implications
If You Believe Markets ARE Efficient:
- Strategy Rationale
- Passive indexing Can't beat the market, so match it
- Minimize costs Fees reduce returns without adding value
- Focus on asset allocation Primary driver of long-term returns
- Tax efficiency One area you can control
- Broad diversification Don't try to pick winners
If You Believe Markets Are INEFFICIENT:
- Strategy Rationale
- Active management Skilled managers can exploit mispricings
- Research and analysis Information analysis can add value
- Concentrated positions High-conviction ideas can outperform
- Factor investing Exploit known anomalies
- The Practical View
Most investment professionals take a middle ground :
- Markets are mostly efficient, most of the time
- Some inefficiencies exist, especially in less-followed markets
- Active management can add value, but it's difficult and costly
- A combination of passive (core) and active (satellite) may be optimal
- On the Exam
Series 65 frequently tests:
- Identifying which form of EMH is described in a scenario
- Understanding what analysis is useful under each form
- Recognizing investment implications of market efficiency
- Knowing that strong form is NOT supported by evidence
- Key Takeaways
- EMH claims prices reflect available information
- Weak form: Past prices reflected—technical analysis useless
- Semi-strong: All public info reflected—fundamental analysis useless
- Strong form: All info reflected—NOT supported by evidence
- Most active managers underperform their benchmarks
- If markets are efficient, passive indexing is the logical choice