Market efficiency means Prices are correct They fully reflect all available information 1+r People use all available information in forming expectations about future cash flows The discount rate is right for the riskness of the cash flows Prices react to new information quickly and to the right extent There is no free lunch The only way you can get higher returns is by taking on more risk There is no information out there that can be used to construct strategies that earn returns higher than required for their risk When we say 'prices are correct', we are implicitly statement what correct we are assuming an asset pricing model)◼ Market efficiency means ◼ Prices are correct ◼ They fully reflect all available information ◼ People use all available information in forming expectations about future cash flows. ◼ The discount rate is right for the riskness of the cash flows. ◼ Prices react to new information quickly and to the right extent ◼ There is no free lunch ◼ The only way you can get higher returns is by taking on more risk ◼ There is no information out there that can be used to construct strategies that earn returns higher than required for their risk. ◼ When we say ‘prices are correct’, we are implicitly statement what ‘correct’ is (i.e., we are assuming an asset pricing model) ( )       + =   + i 1 1 i t i t t r d P E