What does market efficiency refer to?

Market efficiency refers to the speed at which new information is reflected in investment prices. This concept stems from the Efficient Market Hypothesis (EMH), which suggests that financial markets are "informationally efficient." This means that all available information, whether public or private, is quickly incorporated into asset prices, making it difficult for investors to consistently outperform the market through expert stock selection or market timing.

When new information is released—such as earnings reports, economic data, or geopolitical events—an efficient market will react swiftly, adjusting the prices of securities to reflect this new information. This characteristic of markets implies that it is challenging for investors to achieve returns that exceed average market returns, given that any advantage from possessing information would quickly diminish as the market adjusts.

The other options reflect characteristics that do not define market efficiency. The number of investors in the market does not directly relate to how information affects prices. Similarly, while volatility can be a characteristic of market behavior, it does not inherently communicate the efficiency of information processing. Average return on investment is a measure of performance rather than a reflection of how quickly and accurately a market incorporates new information. Understanding market efficiency is crucial for investors and analysts as it influences investment strategies and expectations for financial performance.