What is meant by financial market efficiency?

Financial market efficiency refers to the extent to which asset prices in the market fully reflect all available information. This concept is central to the Efficient Market Hypothesis (EMH), which posits that if markets are efficient, it is impossible to consistently achieve higher returns than average market returns on a risk-adjusted basis, as any new information will quickly be integrated into asset prices.

When markets are efficient, both public and private information are instantly reflected in stock prices, meaning that investors cannot gain an advantage and outperform the average market return by using this information. This can lead to a higher level of confidence among investors, as they know that prices are accurate representations of the underlying value based on available data.

Understanding this concept is crucial for investors and financial professionals, as it impacts investment strategies and approaches to trading. In an efficient market, passive investment strategies may outperform active strategies over the long term due to transaction costs and management fees associated with trying to time the market or pick individual stocks.