ProzacMarket 23model was implying: Prices of shares in stoc kmar kets should adjust
instantaneously and accurately to new information concerning them.
That prediction was embodied in EMT as it was first propounded.
In its broadest terms, EMT said that the prices of shares traded in
stoc kmar kets fully reflect all information concerning those shares.
Stoc kmar kets may or may not have the characteristics assumed
by the perfect market model. As the 1976 Nobel laureate Milton
Friedman reminds us, however, the cardinal rule of economic fore-
casting is that a model’s predictive power is the only relevant test of
its validity, not the assumptions underlying it.^7 Thus, the fact that
investors are not rational or fully informed, for example, does not
matter as long as these realities do not interfere with the predictive
power of EMT. While many economists are reconsidering assump-
tions like these, for now this approach holds sway over accepted
economic theory.
Three Forms of Efficiency
In its general form, EMT explains more than the random walk
model. That model says simply that successive price changes are
independent or uncorrelated, whereas EMT explains that by saying
that stoc kprices fully reflect all the information (not just price his-
tories) about a stock. As a result, virtually since the emergence of
EMT as an explanation of the random wal kmodel, EMT has been
divided into three forms defined in terms of specified categories of
information.
The three forms were first proposed to classify empirical tests of
price behavior given specified kinds of information. The weak form
tested the random wal kmodel itself, using correlation and run tests
like those just described to investigate whether past prices indicate
anything about future prices. Semistrong-form testing investigated
whether publicly available information other than prices was re-
flected in prevailing prices, and strong-form testing investigated
whether private information was reflected in prevailing prices.
As the wealth of tests and discussion proceeded in the 1970s,
the three forms of EMT came to be used to refer to the conclusions
those tests suggested. Thus, the forms of EMT have since then been
specified as follows: The wea kform says that stoc kprices fully reflect
all information consisting of past prices, the semistrong form says
that stoc kprices fully reflect all information that is currently publicly