Market Efficiency

Equity Investments, LOS weight share 1.9 percent of the 365 Level I learning outcomes.

Equity InvestmentsMarket Efficiency

The strongest form of the theory is the one the evidence rejects. Read the type of information, not the strategy's name.

Before you watch

Answer these three first. Getting them wrong now is normal, and it helps the lesson stick. Reveal the answers when you're done, then read on.

1. An investor consistently earns abnormal returns by trading immediately after corporate earnings announcements are released to the public. This behavior is evidence against:

Answer: B. An earnings announcement is public information the instant it is released. If a trader can still earn consistent abnormal returns from it, prices are not fully reflecting public information, which is exactly what semi-strong efficiency claims does not happen.

2. Studies of legal insider trading, purchases by corporate officers using material nonpublic information, consistently show abnormal returns for those insiders. This evidence most directly:

Answer: A. Strong-form efficiency claims even private information is already priced in, so insiders earning abnormal returns directly contradicts it. That same evidence does not contradict semi-strong efficiency, which only claims public information is priced in; private information remaining valuable is exactly what semi-strong would predict.

3. A fund manager claims consistent alpha from a small-cap strategy over 15 statistically significant years. A CFA candidate evaluating this claim under the EMH framework should FIRST consider:

Answer: A. Before treating an apparent anomaly as proof of market inefficiency, the curriculum requires checking whether it has a risk-based explanation. Small-cap stocks carry higher liquidity and distress risk, so the premium may simply compensate for risk rather than represent genuine alpha; this risk-adjustment check comes first.

The lesson

The video lesson for this unit is recorded and waiting to be published. Everything it teaches is written out below.

The reading

Five to ten minutes on this one unit: what the exam wants, the idea in plain words, then straight into the trap and the practice.

The exam wants you to describe market efficiency and the three forms of the efficient market hypothesis, describe the implications of each form for technical, fundamental and insider-based strategies, and describe the market anomalies that appear to challenge efficiency along with the reasons a documented anomaly does not automatically prove a market is inefficient.

The efficient market hypothesis holds that asset prices fully reflect available information, so an investor cannot consistently profit from information the market has already priced in. The word consistently is the load-bearing one: EMH allows a lucky, one-time win. It only rules out a reliable, repeatable edge built on information that is already in the price.

The three forms differ by what counts as available information, and each form's information set fully contains the one before it. Weak form says past price and volume data is already priced in, so technical analysis, chart patterns, moving averages, cannot consistently produce abnormal returns, since it uses only information the market has already absorbed. Semi-strong form extends this to all public information: earnings releases, financial statements, analyst reports, calendar effects. If semi-strong holds, fundamental analysis built entirely from public data cannot consistently beat the market either. Strong form is the broadest claim of all: that not even private information offers an edge.

Here is the trap the exam builds around that hierarchy. Bigger information set does not mean better evidence. Weak and semi-strong form both have reasonable empirical support. Strong form, despite covering the most information of the three, is the one form the evidence actually rejects: studies of legal insider trading, corporate officers whose trades are publicly disclosed on Form 4, consistently show those insiders earning abnormal returns, directly contradicting strong-form efficiency while leaving weak and semi-strong untouched.

A documented anomaly, a pattern that appears to let someone beat the market, only counts as real evidence against EMH after it survives three separate checks. Is the return still there once properly adjusted for risk, since a small-cap or value stock can simply carry more priced risk than a large-cap growth stock does. Does it survive real transaction costs once an investor actually tries to trade on it. Does it still exist once the pattern has been published and other investors start trading against it. Most documented anomalies fail at least one of these three tests. The named anomalies that do get discussed, the January effect, post-earnings-announcement drift, the size and value effects, and momentum, all draw on public data, so their persistence would challenge semi-strong efficiency specifically, not weak or strong form.

The CFA curriculum's own position is a matter of degree, not a binary claim. Markets are informationally efficient to a degree: pricing errors do occur, but they are difficult to exploit consistently, and efficiency itself varies by market, by time period and by the type of information involved. That middle position is neither markets are perfectly efficient nor markets are inefficient and skilled managers can reliably beat them.

The trap

An exam question naming a specific analysis strategy is really asking which form of EMH it tests: read the type of information the strategy uses, past prices for weak form, public data for semi-strong, private data for strong form, rather than the strategy's name.

Learning outcomes covered by this module

Verbatim from the 2026 CFA Level I topic outline. Every practice question and key rule below is tagged to one of these where the stem and explanation make the match clear.

  1. describe market efficiency and related concepts, including their importance to investment practitioners
  2. contrast market value and intrinsic value
  3. explain factors that affect a market's efficiency
  4. contrast weak-form, semi-strong-form, and strong-form market efficiency
  5. explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management
  6. describe market anomalies
  7. describe behavioral finance and its potential relevance to understanding market anomalies

Key rules

Written from this module's own lesson and the 2026 CFA Level I topic outline, in teaching order, each tagged to the learning outcome it belongs to where that is clear.

General

Prices reflect available information; "available" is defined differently by each form

The Efficient Market Hypothesis holds that asset prices fully reflect available information, so an investor cannot consistently profit from information the market has already priced in. The word "consistently" matters: EMH allows lucky one-time returns, it only rules out reliable, repeatable outperformance.

LOS 05

Weak form: past price and volume data is already priced in

If weak-form efficiency holds, technical analysis, chart patterns, moving averages, cannot consistently produce abnormal returns, because it uses only past price and volume information that the market has already absorbed.

LOS 05

Semi-strong form: all public information is already priced in

Semi-strong efficiency covers earnings releases, financial statements, analyst reports and calendar effects, any information publicly available. If semi-strong holds, fundamental analysis built from public data cannot consistently beat the market.

General

Strong form: even private information is already priced in, and the evidence rejects this

Strong-form efficiency is the broadest claim, that not even insider information offers an edge. It is the one form the evidence actually contradicts: studies of legal insider trading (Form 4 disclosures) consistently show corporate insiders earn abnormal returns, directly refuting strong-form efficiency while leaving weak and semi-strong untouched.

General

The forms are hierarchical, but "stronger" does not mean "better supported"

Each form's information set is a superset of the one before it: strong form includes everything semi-strong does, plus private information. That hierarchy is about scope, not evidence. Weak and semi-strong have reasonable empirical support; strong form, despite covering the most information, is the one actually rejected by the data.

General

An anomaly only challenges EMH after surviving three checks

Before treating a documented pattern as proof of inefficiency, the curriculum requires checking whether the return is real after risk-adjustment, whether it survives real-world transaction costs, and whether it still exists after being published. Most anomalies fail at least one of these three tests.

General

Most named anomalies challenge semi-strong form, because they use public data

The January effect, post-earnings announcement drift, and the size and value effects all rely on publicly available information, so their persistence would violate semi-strong efficiency specifically. Momentum, the tendency of recent price trends to continue, also draws on public price history and is generally classified as a semi-strong challenge in the curriculum, since it concerns whether public information (including price trends) is fully and immediately reflected.

General

The official position is a degree of efficiency, not a binary

The CFA curriculum's stance is that markets are informationally efficient to a degree: pricing errors occur, but they are difficult to exploit consistently. This is neither "markets are perfectly efficient" nor "markets are inefficient and skilled managers can reliably beat them"; efficiency varies by market, time period and information type.

The trick

Authored only where a key rule has an arbitrary number, list, or formula shape worth a memory device; a module with none of those has no tricks here, on purpose.

TFI: Technical, Fundamental, Insider

Match the analysis type to the form it tests. Technical analysis tests weak form. Fundamental analysis tests semi-strong. Insider information tests strong form.

WSS: Weak, Semi-strong, Strong

Each form adds a larger information set, like layers of an onion, weak is the smallest, strong is the largest. Larger information set does not mean more evidence in its favor.

SPAM: Size, Post-earnings drift, Anomaly (value), Momentum

The recurring cast of semi-strong-form anomalies, plus the January effect. All rely on publicly available data, which is exactly why they are semi-strong challenges, not weak or strong.

"Consistently" is the load-bearing word

EMH never claims nobody can get lucky once. It claims nobody can reliably, repeatedly beat the market using information that is already priced in. A single good year proves nothing either way.

Strong form is REJECTED, remember the actual insiders who profited

The empirical record on legal insider trading is the direct, real-world evidence that strong-form efficiency does not hold, even though weak and semi-strong retain reasonable support.

The method

Authored, ordered steps for answering this module's question types; a calculation module's calculator-dependent step ends with a bracketed BA II Plus keystroke sequence.

  1. Identify the type of information or analysis in the scenario: past price and volume points to weak form, publicly available data (earnings, filings, calendar effects) points to semi-strong, private or insider information points to strong form.
  2. Watch for the word "consistently" in the question; a single lucky outcome does not challenge any form of EMH, only a reliable, repeatable pattern does.
  3. When an anomaly is presented, run the three-part check before concluding inefficiency: is the return real after risk adjustment, does it survive transaction costs, does it persist after publication.
  4. Remember the hierarchy runs the opposite direction from evidentiary support: strong form covers the most information but is the form the evidence actually rejects.
  5. For a CFA-position question, reach for the middle answer: markets are efficient to a degree, not perfectly efficient and not reliably beatable either.

One card

Condensed from the key rules and tricks above, nothing new. What you'd want on one index card the night before.

Practice questions

Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own explanation. 10 question(s) available for this unit.

Question 1Exam level

According to the weak form of the efficient market hypothesis, which of the following strategies would most likely NOT be expected to consistently earn abnormal returns?

How sure are you?

Correct: A. Weak-form efficiency states that current prices fully reflect all past trading information, including price and volume history. A moving-average crossover signal is a technical strategy built entirely from past price and volume data, so it cannot generate consistent abnormal returns under weak-form efficiency.
B. Buying ahead of earnings announcements trades on information not yet public. That challenges semi-strong form, not weak form, since weak form only concerns past price/volume data.
C. Trading on insider information challenges strong-form efficiency, the strictest form. Weak form makes no claim about private information.

Unit: market-efficiency

Question 2Exam level

A portfolio manager discovers that stocks with high earnings surprises consistently outperform the market for 6 months following the announcement. If this finding is statistically robust, it most likely challenges which form of market efficiency?

How sure are you?

Correct: A. Post-earnings announcement drift (PEAD) is a semi-strong form anomaly. Earnings announcements are public information. If prices do not fully and immediately adjust to this public information, it violates semi-strong efficiency (which holds that all publicly available information is already priced in). It does not challenge weak-form (which only concerns past price data) nor strong-form (which concerns private/inside information).
B. You might be tempted to think that past price data is also relevant here, thus including weak form, but PEAD specifically relates to public information not being fully reflected in prices immediately, which is a semi-strong form issue, not a weak form one.
C. Choosing C might tempt you if you think that insider information is involved, but strong-form efficiency pertains to private or inside information not being exploited, whereas the earnings surprises are public information that semi-strong form efficiency should account for.

Unit: market-efficiency

Question 3Exam level

A research analyst finds that stock returns are significantly higher in January than in other months of the year, even after adjusting for risk. This finding is most consistent with which of the following?

How sure are you?

Correct: B. The January effect is a calendar anomaly. A pattern in publicly available data (month of year) that predicts returns. Its persistence would challenge semi-strong efficiency because month-of-year is a publicly known variable, and if it predicts returns, prices are not fully reflecting all public information. Option A is partially correct but incomplete. Option B contradicts the finding.
A. Option A is partially correct but incomplete.
C. You might be tempted to think that higher January returns indicate a consistent opportunity for alpha, but fundamental analysis relies on company-specific insights rather than calendar patterns, making choice C inconsistent with the observed calendar anomaly.

Unit: market-efficiency

Question 4Harder

Under the strong form of market efficiency, which of the following trading strategies would most likely be expected to consistently earn abnormal returns?

How sure are you?

Correct: A. Strong-form efficiency holds that ALL information, including private/insider information, is already reflected in prices. Therefore, no strategy, not even insider trading, can earn consistent abnormal returns. This is the extreme form and the empirical evidence actually REJECTS strong-form efficiency (studies show corporate insiders and specialists do earn abnormal returns), but by definition, the strong form says no strategy can consistently work.
B. You might think that proprietary models offer an edge over public information, but under strong-form efficiency, even fundamental analysis with unique models cannot consistently earn abnormal returns because all information, including that used in proprietary models, is already priced in.
C. You might be tempted to think that combining both fundamental and technical analysis could exploit market inefficiencies, but under strong-form market efficiency, all information is already priced in, making both approaches ineffective in earning abnormal returns consistently, thus violating the principle that no strategy can outperform in a strongly efficient market.

Unit: market-efficiency

Question 5Exam level

Which of the following pieces of evidence would most likely most strongly SUPPORT semi-strong form market efficiency?

How sure are you?

Correct: A. Semi-strong efficiency predicts that prices adjust rapidly and without systematic bias to all publicly available information. An earnings announcement is the classic public information event. If prices adjust immediately and completely, leaving no profitable trading opportunity after the announcement, this directly supports semi-strong efficiency. Option A contradicts semi-strong (analyst reports are public). Option C contradicts strong-form.
B. Choosing B might seem logical if you think that higher returns for insiders indicate market efficiency, but this actually supports weak-form efficiency being violated, as semi-strong form efficiency implies that all public information, not private information, is already reflected in stock prices.
C. Choosing C might seem logical if you think that momentum investing can persist, but this contradicts semi-strong form efficiency, which posits that all public information is already reflected in stock prices, leaving no room for consistent outperformance based on recent price movements.

Unit: market-efficiency

Question 6Harder

A fund manager claims to have generated consistent alpha by buying small-capitalization stocks and rebalancing quarterly. His track record spans 15 years with statistically significant outperformance. A CFA candidate evaluating this claim under the EMH framework should most likely FIRST consider:

How sure are you?

Correct: A. The size effect (small caps outperforming) is a well-documented anomaly. However, the CFA curriculum teaches candidates to first evaluate whether apparent anomalies have risk-based explanations before concluding market inefficiency. Small-cap stocks have higher liquidity risk, higher distress risk, and higher beta in some specifications. The premium may compensate for these risks rather than represent true alpha from inefficiency. This is the first-order analytical step the CFA tests.
B. Choosing B might tempt you if you assume any outperformance claim requires a conduct check, but evaluating whether outperformance stems from risk premiums aligns with EMH principles, not with ethical standards reviews.
C. Choosing C might tempt you because passive management often involves buying and holding a diversified index, but the question focuses on evaluating the risk-adjusted returns under the EMH framework, not on management style. You should first consider whether the outperformance is due to risk premiums, as per the EMH, rather than assessing the alignment with passive management principles.

Unit: market-efficiency

Question 7Exam level

The Random Walk Hypothesis is most likely most directly associated with which form of market efficiency?

How sure are you?

Correct: B. The Random Walk Hypothesis states that successive price changes are independent. Future price changes cannot be predicted from past price changes. This directly corresponds to weak-form efficiency, which holds that all past trading information (prices, volume) is already reflected in current prices. If prices followed predictable patterns based on past data, technical analysis would work. Which the weak form says it cannot.
A. You might sometimes associate Random Walk with 'all information is random' and choose D. But Random Walk specifically concerns past price data predictability. The definition of weak-form. Semi-strong and strong forms make additional claims beyond price randomness.
C. Choosing C might seem plausible if you think all forms of market efficiency equally reject the idea of predictable price patterns, but this overlooks the specific focus of weak-form efficiency on past price and volume data, which is directly challenged by the Random Walk Hypothesis.

Unit: market-efficiency

Question 8Harder

An investor consistently earns positive abnormal returns by trading immediately after corporate earnings announcements are released to the public. This behavior most likely indicates:

How sure are you?

Correct: B. Trading immediately after a PUBLIC earnings announcement and earning consistent abnormal returns means the market is not fully incorporating publicly available information into prices. A violation of semi-strong efficiency. The information is public (no ethics violation), so this rules out Option A. Earnings announcements are not past price data, so Option B (weak-form) is incorrect.
A. Option B (weak-form) is incorrect.
C. Choosing C might seem logical if you think that positive abnormal returns indicate all information, including insider information, is already priced in, but this confuses strong-form efficiency, which includes private information, with the actual scenario of public information not being fully reflected, which is a violation of semi-strong form efficiency.

Unit: market-efficiency

Question 9Above the exam

A researcher finds that stocks with high past 12-month returns continue to outperform over the following 3-6 months (momentum), a pattern that persists even after accounting for transaction costs, and is not explained by the stocks' exposure to any commonly used risk factor. Combining the definitions of the three forms of market efficiency, this finding is most likely evidence against:

How sure are you?

Correct: A. Momentum is defined using purely historical price/return data (past 12-month returns predicting future returns), which is exactly the information set the WEAK form of market efficiency claims is already fully reflected in prices. A persistent, cost-net-of-transaction-costs, risk-unexplained momentum effect is evidence AGAINST weak-form efficiency specifically, since it shows that past price patterns alone can predict future abnormal returns.
B. The strong form of market efficiency is about whether prices reflect ALL information, including private/insider information; momentum uses only PUBLICLY AVAILABLE past price data, which is squarely the weak-form information set, not a strong-form question.
C. While it is true that weak-form efficiency is logically the most basic level (and its failure does raise questions about the stronger forms too, since they build on similar assumptions about price behavior), the finding as described most directly and specifically targets weak-form efficiency; describing it as evidence against 'both' specific forms named here overstates what a pure price-pattern anomaly directly tests.

Unit: market-efficiency

Question 10Above the exam

A mutual fund manager delivers statistically significant outperformance over 10 years, but careful analysis shows this reflects survivorship bias in the manager's reported track record (many similar funds that underperformed were closed and excluded from the sample) combined with the manager taking on significantly higher systematic risk than the benchmark. Combining these two issues with the concept of risk-adjusted, bias-free performance evaluation, an analyst should most likely conclude that the manager's TRUE, properly evaluated skill is:

How sure are you?

Correct: B. Survivorship bias means the visible sample of long-surviving funds/managers overstates average performance, since the worse performers were removed from the sample over time. Separately, failing to risk-adjust for a manager who took on more systematic risk than the benchmark means some of the raw outperformance simply compensates for that extra risk, not genuine skill. Combining both corrections (removing the survivorship inflation AND properly risk-adjusting), the manager's true outperformance is very likely much smaller than the raw, unadjusted track record suggests.
A. Raw, statistically significant outperformance in a track record that suffers from BOTH survivorship bias and unadjusted risk-taking cannot be taken at face value; both issues specifically work to inflate the APPARENT skill shown in the raw numbers.
C. The existence of survivorship bias and unadjusted risk does not make performance evaluation meaningless; it means analysts must correct for these specific, well-understood biases (using survivorship-bias-free databases and risk-adjusted measures), not abandon evaluation altogether.

Unit: market-efficiency

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