WILEY BLACKWELL American Finance Association Efficient Capital Markets: A Review of Theory and Empirical Work Author(s): Eugene F. Fama Source: The Journal of Finance, Vol 25, No 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May,1970),p.383-117 Published by: Blackwell Publishing for the American Finance Association StableUrl:http://www.jstor.org/stable/2325486 Accessed:30/03/201021:28 Your use of the JStOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jspJstOr'sTermsandConditionsofuSeprovidesinpartthatunless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work, Publisher contact information may be obtained at http://www.jstor.org/action/showpublisher?publishercode=black Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission JStOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor. org Blackwell Publishing and American Finance Association are collaborating with JSTOR to digitize, preserve and extend access to The Journal of finance OR ittp://www.jstor.org
American Finance Association Efficient Capital Markets: A Review of Theory and Empirical Work Author(s): Eugene F. Fama Source: The Journal of Finance, Vol. 25, No. 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May, 1970), pp. 383-417 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2325486 Accessed: 30/03/2010 21:28 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=black. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Blackwell Publishing and American Finance Association are collaborating with JSTOR to digitize, preserve and extend access to The Journal of Finance. http://www.jstor.org
SESSION TOPIC: STOCK MARKET PRICE BEHAVIOR SESSION CHAIRMAN: BURTON G. MALKIEL EFFICIENT CAPITAL MARKETS: A REVIEW OF THEORY AND EMPIRICAL WORK* EuGENE F FAMA** I.Ⅰ NTRODUCTION THE PRIMARY ROLE of the capital market is allocation of ownership of the economys capital stock. In general terms, the ideal is a market in which prices provide accurate signals for resource allocation: that is a market in which firms can make production-investment decisions, and investors can choose among the securities that represent ownership of firms' activities under the assumption that security prices at any time fully reflect"all available in formation. a market in which prices always "fully reflect"'available informa tion is called"efficient This paper reviews the theoretical and empirical literature on the efficient markets model. After a discussion of the theory, empirical work concerned with the adjustment of security prices to three relevant information subset is considered. First, weak form tests, in which the information set is jus historical prices, are discussed. Then semi-strong form tests, in which the con- cern is whether prices efficiently adjust to other information that is obviously publicly available (e. g, announcements of annual earnings, stock splits, etc. are considered. Finally, strong form tests concerned with whether given in vestors or groups have monopolistic access to any information relevant for price formation are reviewed We shall conclude that with but a few ex ceptions, the efficient markets model stands up well Though we proceed from theory to empirical work, to keep the proper historical perspective we should note to a large extent the empirical work in this area preceded the development of the theory. The theory is presented first here in order to more easily judge which of the empirical results are most relevant from the viewpoint of the theory. The empirical work itself, however will then be reviewed in more or less historical sequence Finally, the perceptive reader will surely recognize instances in this paper where relevant studies are not specifically discussed. In such cases my apol ogies should be taken for granted. The area is so bountiful that some such injustices are unavoidable. But the primary goal here will have been complished if a coherent picture of the main lines of the work on efficient markets is presented, along with an accurate picture of the current state of the arts * upported by a grant from the National Science Foundation. I am indebted Robert Aliber, Ray Ball, Michael Jensen, James Lorie,Merton Miller Charles Nelson Roll, william Taylor, and Ross Watts for their helpful comments * University of Chicago-Joint Session with the Econometric Society 1. The distinction between weak and strong form tests was first suggested by harry Roberts 38
The Journal of finance II. THE THEORY OF EFFICIENT MARKETS A. Expected Return or“ Fair Game” Models The definitional statement that in an efficient market prices"fully reflect available information is so general that it has no empirically testable implica tions. To make the model testable, the process of price formation must be specified in more detail. In essence we must define somewhat more exactly what is meant by the term“ fully reflect.” One possibility would be to posit that equilibrium prices (or expected re- turns)on securities are generated as in the "two parameter?"Sharpe [40] Lintner [24, 25] world. In general, however, the theoretical models and es- pecially the empirical tests of capital market efficiency have not been this specific. Most of the available work is based only on the assumption that the conditions of market equilibrium can (somehow) be stated in terms of ex- pected returns. In general terms, like the two parameter model such theories would posit that conditional on some relevant information set, the equilibrium expected return on a security is a function of its"risk " And different theories would differ primarily in how“risk” is defined 6 All members of the class of such"expected return theories"can, however, described notationally as follow E(pt+1)=[1+E(f1t+1)]py where E is the expected value operator; pjt is the price of security j at time t pi, t+1 is its price at t+ 1 (with reinvestment of any intermediate cash income from the security ) r3, t+1 is the one-period percentage return(p t+1-pjt )/ pit; t is a general symbol for whatever set of information is assumed to be fully reflected "in the price at t; and the tildes indicate that pit+1 and ry,t+1 are random variables at t The value of the equilibrium expected return E(f,. ++@t)projected on the basis of the information pt would be determined from the particular expected return theory at hand. The conditional expectation notation of (1)is meant to imply, however, that whatever expected return model is assumed to apply, the information in pt is fully utilized in determining equilibrium expected returns. And this is the sense in which t is"fully reflected"in the formation But we should note right off that, simple as it is, the assumption that the conditions of market equilibrium can be stated in terms of expected returns elevates the purely mathematical concept of expected value to a status not cessarily implied by the general notion of market efficiency. The expected value is just one of many possible summary measures of a distribution of returns, and market efficiency per se (i.e, the general notion that prices"fully reflect " available information) does not imbue it with any special importance. Thus, the results of tests based on this assumption depend to some extent on its validity as well as on the efficiency of the market. But some such assump- tion is the unavoidable price one must pay to give the theory of efficient markets empirical content. The assumptions that the conditions of market equilibrium can be stated
Eficient Capital Markets 385 in terms of expected returns and that equilibrium expected returns are formed on the basis of (and thus" fully reflect " the information set t have a major empirical implication-they rule out the possibility of trading systems based only on information in t that have expected profits or returns in excess of equilibrium expected profits or returns. Thus let E(P3+1|重) Then E(xt+1|)=0 (3) which, by definition, says that the sequence(x3t) is a fair game"with respect to the information sequence (%t]. Or, equivalently, let t+1=rt+1-E(ft+1④), (4) E(2t+1D) so that the sequence (Zjt) is also a " fair game "with respect to the information sequence [) In economic terms, x, t +1 is the excess market value of security j at time t+1: it is the difference between the observed price and the expected value of the price that was projected at t on the basis of the information t. And similarly, zj, t+1 is the return at t+ 1 in excess of the equilibrium expected return projected at t. Let a(4)=[a1(t),a2(t),…,an(t) be any trading system based on which tells the investor the amounts a @t) of funds available at t that are to be invested in each of the n available secu- rities. The total excess market value at t+ 1 that will be generated by such a V+1=2吗(4)[r…+1-E(E+1)], game"property of(5)has expectatic E(W+1厘)=2a(亚)E(动t+1)=0 The expected return or "fair game efficient markets model has other important testable implications, but these are better saved for the later dis cussion of the empirical work. Now we turn to two special cases of the model the submartingale and the random walk, that (as we shall see later)play an important role in the empirical literature 2. Though we shall sometimes refer to the model summarized by(1)as the "fair game" model, keep in mind that the "fair game properties of the e implications of the assumptions that (i) the conditions of market equilibrium can be stated in terms of expected returns, and (ii)the nformation pt is fully utilized by the market in equilibrium expected returns and thus current he role of fair game models in the theory of efficient markets was first recognized and ously by Mandelbrot [27] and Samuelson [38]. Their work will be discussed in more detail late
al o f Fi B. The Submartingale Model Suppose we assume in(1) that for all t and t E(3t+11)≥pu, or equivalently,E(行t+1{)≥0 This is a statement that the price sequence pjt) for security j follows a sub martingale with respect to the information sequence (,), which is to say nothing more than that the expected value of next periods price, as projected on the basis of the information t is equal to or greater than the current price If (6)holds as an equality(so that expected returns and price changes are ero), then the price sequence follows a martingale a submartingale in prices has one important empirical implication. Consider the set of"one security and cash"mechanical trading rules by which we mea systems that concentrate on individual securities and that define the conditions under which the investor would hold a given security, sell it short, or simply hold cash at any time t. Then the assumption of(6) that expected returns conditional on t are non-negative directly implies that such trading rules based only on the information in t cannot have greater expected profits than a policy of always buying-and-holding the security during the future period in question. Tests of such rules will be an important part of the empirical evidence on the efficient markets model.a C. The Random Walk Model rly treatments of the efficient markets model, the statement that price of a security "fully reflects'"'available information was assumed to imply that successive price changes (or more usually, successive one-period returns) are independent. In addition, it was usually assumed that successive changes (or returns )are identically distributed. Together the two hypotheses constitute the random walk model. Formally, the model says f(r3+1④+)=f(r;t1), which is the usual statement that the conditional and marginal probability distributions of an independent random variable are identical. In addition the density function f must be the same for all t. 3. Note that the expected profitability of "one see and-hold is not ruled out by the general expected since in principle it allows equilibrium expected returns to be negative, holding cash(which has zero actual and thus expected return) may have higher expected return than holding d negative equilibrium expected returns for some securities are quite possible. For example, models of Markowitz [30] and Tobin [43]) the equilibrium expected return on a security depends the extent to which the dispersion in the security's return distribution is related to dis in the returns on al curities. A security whose returns on average move opposite to the general market is particularly valuable in reducing dispersion of portfolio returns, and so its quilibrium expected return may well be negative m only follow a random walk if price changes are If one-period returns are independent, id ill not follow a random walk since the distribution of price changes m啦