by Frank Shostak
It is widely held that financial asset markets always fully reflect all available and relevant information, and that adjustment to new information is virtually instantaneous. This way of thinking which is known as the Efficient Market Hypothesis (EMH) is closely linked with the modern portfolio theory (MPT), which postulates that market participants are at least as good at price forecasting as is any model that a financial market scholar can come up with, given the available information. The view that everyone is as good a forecaster as any model implies that their forecasts do not display systematic biases. In other words, their forecasts are right on average. According to the MPT, by using available information, all market participants arrive at “rational expectations” forecasts of future security returns, and these forecasts become fully reflected in the prices that are observed in financial markets.