In an efficient market, investors should not expect to earn superior returns without taking additional risk.
If one investment gives a higher expected return, it is usually because it carries higher risk. Market efficiency suggests that prices adjust in such a way that return and risk remain connected.
Example:
Suppose a government bond gives a return of 7% per year and a small company stock gives an expected return of 15% per year.
The higher return from the stock does not mean free profit. It may reflect higher business risk, price volatility, and uncertainty.
If the stock was offering 15% return with the same risk as the bond, many investors would buy it. This buying pressure would increase the stock price and reduce its expected return.
So, in efficient markets, higher returns usually come with higher risk.
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