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