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I am confused by the relation between stocks market prices and fundamental (or intrinsic) values stated by Efficient Market Hypothesis. How these deviates regarding to efficient market theory or are these the same according to EMH?

Why I am asking this is because among the literature, there can be found two kind of statements.

This is the very general statement that can be found from here and there:

Investopedia: This principle is called the Efficient Market Hypothesis (EMH), which asserts that the market is able to correctly price securities in a timely manner based on the latest information available. Based on this principle, there are no undervalued stocks to be had, since every stock is always trading at a price equal to its intrinsic value **.

The another one what can be found from academic literature and books, states:

Fama (1965) In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.

and line with previous, other source states :

Market efficiency does not require that the market price be equal to true value at every point in time. All it requires is that errors in the market price be unbiased, i.e., that prices can be greater than or less than true value, as long as these deviations are random

I also saw algebraig illustration where it was shown that the market price estimates the fundamental value of security better any individual trader can estimate it. (with certain assumptions)

So the question is, why here and these is stated, that in efficient market, the market price of stock is trading at a price equal to fundamental (or intrinsic) value? Which is right?

And if the market price is at the best good estimate of intrinsic value, how can it be stated that in efficient market there are not under- or overvalued stocks, if the market price is only best estimate of instrinsic value?

I am not very familiar with algebraig definitions, but some kind of clarification behind this issue would be appreciated.

Thank you for clarification.

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The fundamental value of an asset over an infinite horizon is the sum of dividends discounted over time.

You are stumbling into the literature on rational and irrational bubbles. In general, the difference between the fundamental value of an asset and its market price constitutes, to some degree, bubble behavior.

Edit — I can probably expand this for clarity. Each of those definitions tries to get at the same thing — there is no room for systematic bias in the prices of assets traded on the market. Markets, more or less, are powerful because they aggregate massive amounts of information. They incorporate ever trader’s wants, fears, expectations, etc. and distill it all into a single thing — a price. And markets do this very quickly. We can see this, for example, when markets adjust to incorporate information shocks that occur around FOMC statements. Because of this, it should be true that prices do not deviate systematically from fundamentals. The argument boils down to one of arbitrage opportunities, I suppose.

However, many economists (many people, really) openly discuss bubbles. A bubble, rather loosely stated, exists if prices deviate systematically from fundamentals. The common theme of each definition above is that we should see systematic deviations on prices away from fundamentals. They just vary a bit in how emphatically they say this. Nevertheless, we all talk about bubbles.

Also — how do we know if prices have deviated from fundamentals? Well, there is a nice literature built around this idea, but I am not convinced this is possible to do with empirical data. However, economists have used the laboratory to show that this happens in markets. In fact, generating bubbles in an asset market is probably among the most reproducible laboratory phenomena I can think of.

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  • $\begingroup$ Sorry, but i do not get the point here. Both of definitions are based on Efficient Market Hypothesis literature. No discussion about bubbles there, just a basics behind the efficient market theory. $\endgroup$ – Lothilla Nov 22 '19 at 17:39
  • $\begingroup$ The question asks about the difference between market price and the fundamental value of an asset. That is, definitely, about bubbles. $\endgroup$ – 123 Nov 23 '19 at 21:08
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Sorry for the late answer and thank you for your clarification. I really appreciate it!

So could this be interpreted as follows: "every stock is always trading at a price equal to its intrinsic value" argument states the same thing as Fama states that "market price is good estimate of fundamental value" that the key point between the deviation between market price and fundamental value is there is no systematical bias? So basically from this point of view, that there is no systematical bias, efficient market hypothesis states that fundamental value and market price equals in this manner. In other words, there can be bias but no in systematical manner ie. the error or deviation is random? And because it is random, in average market price and fundamental value is the same thing or can be said "good estimate" in other words? Did i interpret it correctly in general?

And yes i think i got it and you were right about the bubbles, if there is deviation in systematic manner between these two ie. market price and fundamental value, we speak about bubbles.

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