Efficient Markets
Another implication of the no-free-lunch proposition is that we should rarely expect to find bargains in the security markets. There is a hypothesis that the security price usually reflects all the information available to investors concerning its value. According to this hypothesis, as new information about a security becomes available, its price quickly adjusts so that at any time, the security price equals the market consensus estimate of the value of the security. If this were so, there would be neither underpriced nor overpriced securities.
One interesting implication of this “efficient market hypothesis” concerns the choice between active and passive investment-management strategies. Passive management calls for holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis. Active management is the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes - for example, increasing one’s commitment to stocks when one is bullish on the stock market. If markets are efficient and prices reflect all relevant information, perhaps it is better to follow passive strategies instead of spending resources in a futile attempt to outguess your competitors in the financial markets.
If the efficient market hypothesis were taken to the extreme, there would be no point in active security analysis; only fools would commit resources to actively analyse securities. Without ongoing security analysis, however, price eventually would depart form “correct” values creating new incentives for experts to move in. Therefore, even in environments opportunities may exist for especially diligent and creative investors.
(source: Investments)
Another implication of the no-free-lunch proposition is that we should rarely expect to find bargains in the security markets. There is a hypothesis that the security price usually reflects all the information available to investors concerning its value. According to this hypothesis, as new information about a security becomes available, its price quickly adjusts so that at any time, the security price equals the market consensus estimate of the value of the security. If this were so, there would be neither underpriced nor overpriced securities.
One interesting implication of this “efficient market hypothesis” concerns the choice between active and passive investment-management strategies. Passive management calls for holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis. Active management is the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes - for example, increasing one’s commitment to stocks when one is bullish on the stock market. If markets are efficient and prices reflect all relevant information, perhaps it is better to follow passive strategies instead of spending resources in a futile attempt to outguess your competitors in the financial markets.
If the efficient market hypothesis were taken to the extreme, there would be no point in active security analysis; only fools would commit resources to actively analyse securities. Without ongoing security analysis, however, price eventually would depart form “correct” values creating new incentives for experts to move in. Therefore, even in environments opportunities may exist for especially diligent and creative investors.
(source: Investments)
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