A.06.BKM Ch 11

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A.06.BKM Ch 11
2012-05-09 14:42:39

Efficient Market Hypothesis
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  1. EMH
    • stock prices should reflect all available info
    • new info comes in in random walk process and causes price to change
  2. Versions of the EMH
    • weak form: stock prices reflect all info derived from historical data
    • semistrong form: all publicly available information about firm's prospects
    • strong form: all info relevant to firm, incl inside info
  3. EMH vs Investment strategies
    • technical analysis: search for predictable patterns. Useless if weak form holds
    • fundamental analysis: use firm's fundamentals to gain insight on future performance. Only works if unique insight
    • conclusion: active only for large, small use mutual funds or passive
  4. Event study
    • determining the importance of an event by measuring chg in stock price
    • (-) market movement: should look at abnormal return = actual - benchmark (using mkt, CAPM, Index Model)
    • (-) leakage: should look at cumulative abnormal return starting before event is public
  5. Are markets efficient? Issues
    • magnitude issue: hard to distinguish extra return from normal fluctuations
    • selection bias issue: once scheme is public, no longer holds
    • lucky event issue: very large # of investors implies some will make huge returns
  6. Are markets efficient? Tests
    • weak form tests: short term serial correlation shows momentum effect, long term negative correlation from fads hypothesis
    • semistrong tests: small-firm-in-january, neglected firm effect, book-to-market ratio, post-earning annoucement price drifts
    • strong tests: mkts are not expected to be strong-form efficient
    • conclusion: results above arise because (1) properties are proxies for determinant of risk (2) arise from data mining
  7. Role of pf mgt in efficient mkt
    • diversification: eliminate firm-specific risk
    • reflect tax considerations of individual investors
    • adjust pf to reflect unique risk profile of investor