What Eugene Fama Really Says About Efficient Markets
Eugene Fama’s Efficient Market Hypothesis (EMH) is one of the most important—and misunderstood—ideas in modern finance. Often caricatured as claiming that markets are perfectly priced and impossible to beat, Fama’s actual position is far more nuanced.
In this post, we explore what Fama really says about market efficiency, how he thinks about models, and why even he doesn’t claim that markets are 100 per cent efficient.
What is the Efficient Markets Hypothesis?
Fama defines an efficient market as one in which prices ‘fully reflect all available information’ (Fama 1970). But crucially, this doesn’t mean that prices are always correct in some fundamental sense. Rather, it means that:
Prices respond so quickly to new information that it is extremely difficult to systematically profit from mispricings after costs and risk.
To clarify what ‘available information’ means, Fama (1970) proposed three forms of market efficiency:
1. Weak-Form Efficiency
Definition:
All past prices and trading data (such as historical price trends, volumes, and returns) are fully reflected in current asset prices.
Implication:
You cannot consistently earn excess returns by studying past price movements or patterns. This renders technical analysis (or charting) ineffective as a long-term strategy for beating the market.
Evidence:
Most developed markets show strong support for weak-form efficiency, particularly over long time horizons. Price movements appear close to random walks, with little predictive power from past data.
2. Semi-Strong Form Efficiency
Definition:
All publicly available information—including financial statements, earnings announcements, macroeconomic data, analyst reports, and news releases—is already incorporated into prices.
Implication:
You cannot consistently outperform the market by analysing publicly available information. This invalidates the premise of fundamental analysis as a reliable path to alpha, after adjusting for costs and risk.
Evidence:
Numerous studies, such as event studies on earnings surprises or stock splits, suggest that markets adjust rapidly to new public information. However, some anomalies (e.g. momentum, value effects) challenge the strictest version of this form.
3. Strong-Form Efficiency
Definition:
All information, both public and private (insider information), is reflected in market prices.
Implication:
No investor, not even insiders, can earn abnormal returns consistently. This would imply total informational parity across the market.
Evidence:
This form is generally rejected. Insider trading scandals and academic evidence show that those with access to material non-public information can outperform. Regulators explicitly prohibit insider trading because of its exploitative potential.
Fama himself is sceptical of strong-form efficiency, acknowledging that insider trading can and does occur.
Not 100 Per Cent Efficient – And That’s OK
Contrary to popular belief, Fama has never claimed that markets are perfectly efficient. In fact, he has said the opposite:
‘The market is not perfectly efficient. It's just a good working hypothesis.’
— Fama, quoted in Dimensional Fund Advisors (2004)
In other words, EMH is not a universal law. It is a useful benchmark—a way of thinking about how prices generally behave in competitive, information-rich markets.
Fama (1991) also made it clear that efficiency exists on a spectrum, and that the degree of efficiency can vary across markets and over time.
What matters, then, is not whether markets are perfect, but whether the inefficiencies are large, persistent, and exploitable enough to justify the costs of active management. Fama’s answer, backed by decades of research, is generally no.
On Mispricing, Bubbles, and Behaviour
So what about market bubbles or irrational investor behaviour? Fama is famously sceptical of such claims:
‘I don’t even know what a bubble means.’
— Fama, CNBC interview (2010)
This isn’t denialism—it’s a methodological critique. Fama argues that we cannot define a bubble purely in hindsight by saying prices fell. To prove a bubble, one must show that prices deviated from intrinsic value at the time, in a predictable and exploitable way. Behavioural finance, in his view, often lacks this kind of rigour.
That said, he acknowledges that some anomalies appear in the data. But in Fama (1998), he argues that these are often statistical noise, the result of data mining, or disappear after publication.
The Joint Hypothesis Problem
One of Fama’s most important contributions is the joint hypothesis problem. This is the idea that:
You can’t test market efficiency in isolation—you must also assume a model of expected returns.
So when a strategy appears to ‘beat the market’, it’s not clear whether:
The market is inefficient, or
The model you’re using (like the CAPM) is wrong.
This makes testing EMH empirically challenging—and means that evidence of mispricing is always conditional on the model used (Fama 1991).
On Models: ‘All Models Are False’
Fama is pragmatic about financial models. He doesn’t claim that they are accurate depictions of reality—just useful approximations.
‘All models are false by definition—they are simplifications. The question is whether the simplification is good enough to be useful.’
— Fama and French (2004)
This mindset shaped Fama and French’s own evolution from the CAPM to the three-factor and five-factor models. When the CAPM failed to explain cross-sectional stock returns, they didn’t throw it away—they built a better approximation.
Likewise, EMH should be seen as a baseline model. If someone wants to claim that markets are inefficient, the burden is on them to demonstrate a systematic, reliable way to exploit those inefficiencies.
So… Are Markets Efficient?
The honest answer, from Fama’s own perspective, is: not perfectly—but efficient enough that most investors are better off assuming they are.
Markets are noisy, but beating them consistently is extremely difficult.
Prices may be wrong, but in ways that are unpredictable and not exploitable after costs.
Models are not reality, but useful tools for understanding it.
In that light, the strongest case for market efficiency is practical, not theoretical. Over decades, study after study finds that very few investors beat the market persistently—and that even those who do often fail to justify their fees.
References
CNBC. 2010. Interview with Eugene Fama on Market Bubbles. 25 January 2010. https://www.cnbc.com/id/35020149
Dimensional Fund Advisors. 2004. Conversations with Eugene Fama. https://www.dimensional.com
Fama, Eugene F. 1970. ‘Efficient Capital Markets: A Review of Theory and Empirical Work.’ Journal of Finance 25 (2): 383–417. https://doi.org/10.2307/2325486
Fama, Eugene F. 1991. ‘Efficient Capital Markets: II.’ Journal of Finance 46 (5): 1575–1617. https://doi.org/10.1111/j.1540-6261.1991.tb04636.x
Fama, Eugene F. 1998. ‘Market Efficiency, Long-Term Returns, and Behavioral Finance.’ Journal of Financial Economics 49 (3): 283–306. https://doi.org/10.1016/S0304-405X(98)00026-9
Fama, Eugene F., and Kenneth R. French. 2004. ‘The Capital Asset Pricing Model: Theory and Evidence.’ Journal of Economic Perspectives 18 (3): 25–46. https://doi.org/10.1257/0895330042162430