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All About Hedge Funds, Fully Revised Second Edition, 2nd Edition by Ezra Zask

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CHAPTER 22Behavioral Critique of Efficient Market Hypothesis

The efficient market hypothesis (EMH) is another aspect of modern portfolio theory that states that an investor cannot consistently earn returns above the average returns of the market. A corollary of the hypothesis is that markets follow a “random walk” that precludes the possibility of predicting or gaining from market trends. According to the hypothesis, any deviation from efficient market prices will be exploited by arbitrage until the deviation is eliminated. Clearly, the EMH presents a challenge for hedge funds. If it is true, then hedge funds would be unable to generate risk-adjusted returns that are better than the average returns available in the marketplace, for example by ...

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