What does "market efficiency" refer to?

"Market efficiency" refers to the extent to which stock prices reflect available information. This concept is a fundamental principle in finance that suggests that in an efficient market, all relevant information is already incorporated into stock prices, meaning that it would be impossible to consistently achieve higher returns than the average market return on a risk-adjusted basis by using that information.

When a market is efficient, any new information that becomes available is quickly analyzed and acted upon by investors, leading to immediate adjustments in stock prices. This efficiency can be categorized into different forms, such as weak, semi-strong, and strong efficiency, depending on the type of information considered (historical prices, public information, or all information including insider information).

The other options do not accurately capture the essence of market efficiency. The balance between supply and demand relates more to basic market operations than to efficiency itself, while the rate of return on investments pertains to performance rather than how information impacts price. Lastly, volatility addresses price fluctuations but does not indicate whether those fluctuations reflect available information effectively. Therefore, the correct understanding of market efficiency is crucial for evaluating investment strategies and market behavior.