24 ATaleofTwoMarkets
available; and the strong form (hold your breath) says that stock
prices fully reflect all existing information, whether publicly available
or not.
There is thus a direct and logical lin kbetween the random wal k
model and weak-form efficiency but a more attenuated and contin-
gent lin kbetween the random wal kmodel and stronger forms of
EMT. Recall that the random wal kmodel holds that price changes
are independent of or uncorrelated with prior price changes. That
means that technical analysis of past price changes—sometimes
called chartist analysis—cannot aid the prediction of future price
changes in any systematic way.
Weak-form efficiency explains this independence and its impli-
cations for prediction by hypothesizing that the current price im-
pounds all information contained in prior prices. Thus, any price
change can only be the result of new information, the production of
which is itself assumed to be random. This process of information
absorption continues and thus explains the absence of substantial
linear dependence in successive price changes discovered in the cor-
relation and run tests of the 1960s. It also leads to the stronger forms
of the hypothesis.
The semistrong form of EMT posits not only that current stock
prices reflect all information consisting of prior stoc kprices but also
that they reflect all publicly available information about the stoc kin
question. Testing this more ambitious claim requires a focus not on
correlation analysis of price changes but on the relative swiftness
with which prices change given new information.
Despite this different testing methodology, semistrong efficiency
depends on the validity of the random wal kmodel, which depends
in turn on empirical conclusions concerning the absence of statis-
tical dependence in stoc kprice data. In other words, if future price
changes depend on prior price changes, any price change the semi-
strong form tests cannot be attributable solely to the new infor-
mation the test is evaluating. Thus, both wea kefficiency and semi-
strong efficiency depend on the proof provided by linear testing
models.
The strong form of EMT extends much farther than the random
wal kmodel suggested. Indeed, the strong form is a theological prop-
osition, holding that public capital markets are infinitely wise: even
nonpublic information is reflected in public stoc kprices. Abundant
evidence has decimated the strong form by showing that people who
possess nonpublic information can use it to make abnormally high