2.4.3. Strong-Form Tests

Strong-form tests are used to assess whether professional investors have monopolistic access to all private, as well as public, information so that they can outperform the market. Jensen (1968) evaluates the performance of mutual funds over the nineteen-year period of 1945–1964, on a risk-adjusted basis. The findings indicate that the funds cannot beat the market in favor of the strong-form market efficiency, regardless of whether loading charges, managemen<sup>t</sup> fees, and other transaction costs are ignored.

Table 1 briefly summarizes Fama's (1970) taxonomy of EMH tests.



#### *2.5. Explaining Market E*ffi*ciency by Factor Models*

Under the traditional framework of rational and frictionless agents, the price of a security equals its "fundamental value". This is the present value sum of expected future cash flows, where at the time of forming the expectation, the investor handles all available information properly, and the discount rate is in line with the normal acceptable preference norm. In an efficient market, no investment strategy can obtain a risk-adjusted excess average return, or higher than the average return guaranteed by its risk, which means that there is no "free lunch" (Barberis and Thaler 2003). If EMH is applied to understand the volatility of stock market prices, there should be enough evidence to justify price changes, by showing that real investment values change over time.

Taking the American stock market as an example, from 1871 to 1986, the change of the total real investment value of the stock market was measured by three factors: the change of dividend, the change of real interest rate, and the direct measure of the inter-period marginal substitution rate (Shiller 1987). In this section, we introduce some famous models, using different factors that help examine reasons behind price changes of securities or abnormal profits. Although there are abnormal profits in the market, as long as methods are provided to predict or calculate the price that brings out the abnormal returns, the abnormal profits will return to zero and make the market efficient again, with the help of rational arbitrageur's buying low and selling high.
