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CHAPTER 9: MARKET EFFICIENCY

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Objective: To discuss the efficient market hypothesis and to ... Superstar phenomenon. eg. Peter Lynch, Warren Buffet. Mutual funds do not outperform index ... – PowerPoint PPT presentation

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Title: CHAPTER 9: MARKET EFFICIENCY


1
CHAPTER 9 MARKET EFFICIENCY
2
Chapter Summary
  • Objective To discuss the efficient market
    hypothesis and to examine the empirical evidence
    supporting or not the notion of market
    efficiency.
  • The Efficient Market Hypothesis
  • Empirical Tests of Market Efficiency

3
What is the Efficient Market Hypothesis (EMH)?
  • Stock prices reflect all available info
  • Why? If info says its underpriced, everyone will
    buy it and price will go up
  • Random Walk - stock prices change unpredictably
    and randomly
  • Actually stock prices follow a submartingale
    (next slide)
  • Expected price is positive over time
  • Positive trend and random around the trend

4
Random Walk with Positive Trend
5
Random Price Changes
  • Why are price changes random?
  • Prices react to information
  • Flow of information is random
  • Therefore, price changes are random

6
EMH and Competition between fund managers
  • Stock prices fully and accurately reflect
    publicly available information
  • Once information becomes available, market
    participants analyze it
  • Competition assures prices reflect information

7
If markets are efficient, why research?
  • Research is expensive
  • Research wont be done for ALL stocks

8
3 forms of EMH
Weak form
Semi-strong form
Strong form
9
Forms of the EMH(3 versions of EMH)
  • Versions of EMH define available info
  • Weak all past market trading information
  • Semi-strong all publicly available information
    regarding the prospects of a firm
  • Strong all information relevant to the firm

10
Implications of EMH for investors
  • Technical Analysis - using prices and volume
    information to predict future prices
  • EMH waste of time
  • Fundamental Analysis - using economic and
    accounting information to predict stock prices
  • EMH waste of time

11
Implications of EMH
  • Investors make a fair return on their investment
  • Markets will be efficient only if enough
    investors believe they are not efficient
  • Public strategies cannot generate high returns
  • Some portfolio mgrs will be consistently good

12
Market Efficiency and Portfolio Management
  • EMH advocates passive investment strategy
  • (ie. Buy and hold)
  • Is there a role that exists for portfolio
    management?
  • It costs to analyze securities
  • Diversification
  • Appropriate risk level know your client
  • Tax considerations

13
Summary Reminder
  • Objective To discuss the efficient market
    hypothesis and to examine the empirical evidence
    supporting or not the notion of market
    efficiency.
  • The Efficient Market Hypothesis
  • Empirical Tests of Market Efficiency

14
Empirical Tests of Market Efficiency
  • Event studies
  • Assessing performance of professional managers
  • Testing some trading rules

15
What do EMH tests reveal?
Anomalies to EMH exist
  • Small Firm Effect (January Effect)
  • Neglected Firm
  • Book to Market Ratios
  • Reversals
  • Weekend effect
  • Post-earnings announcement drift

16
Mutual Fund and Professional Managers Performance
  • Do professional managers beat the market?
  • EMH has some anomalies
  • Some evidence of persistent positive and negative
    performance of various mgrs
  • Superstar phenomenon
  • eg. Peter Lynch, Warren Buffet
  • Mutual funds do not outperform index
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