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Efficient versus Inefficient Market PowerPoint PPT Presentation

Efficient versus Inefficient Market Market Efficiency Random walk versus market efficiency Versions of market efficiency Technical analysis Predictors of future returns and market anomalies Behavioral finance Cumulative Abnormal Returns Around Takeover Attempts: Target Companies

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Efficient versus Inefficient Market

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Efficient versus Inefficient Market

  • Market Efficiency

    • Random walk versus market efficiency

    • Versions of market efficiency

    • Technical analysis

    • Predictors of future returns and market anomalies

    • Behavioral finance


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Cumulative Abnormal Returns Around Takeover Attempts: Target Companies


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Stock Price Reaction to CNBC Reports


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EMH and Competition

  • Stock prices fully and accurately reflect publicly available information.

  • Once information becomes available, market participants analyze it.

  • Competition assures prices reflect information.

  • Read “Are Markets Efficient?” on page 387


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Forms of the EMH

  • Weak

  • Semi-strong

  • Strong

    • See page 361.


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Types of Stock Analysis

  • Technical Analysis - using prices and volume information to predict future prices.

    • Weak form efficiency & technical analysis

    • Chartist

    • Relative strength versus resistance levels

  • Fundamental Analysis - using economic and accounting information to predict stock prices.

    • Semi strong form efficiency & fundamental analysis


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Trend and Corrections

  • Dow theory – page 407-409

    • Primary trend

    • Secondary/intermediate trend

    • Tertiary or minor trends

  • Moving average

    • Typically 200 days or 53 weeks

    • Bullish versus bearish – page 411

  • Breadth – page 411

    • Advances versus declines – page 411

  • Sentiment indicator

    • Trin statistic

    • Confidence index

    • Put-call ratio


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Active or Passive Management

  • Active Management

    • Security analysis

    • Timing

  • Passive Management

    • Buy and Hold

    • Index Funds


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Market Efficiency & Portfolio Management

Even if the market is efficient a role exists for portfolio management:

  • Appropriate risk level

  • Tax considerations

  • Other considerations


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Empirical Tests of Market Efficiency

  • Event studies

  • Assessing performance of professional managers

  • Testing some trading rule


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Issues in Examining the Results

  • Magnitude Issue

  • Selection Bias Issue: investing in small stocks

  • Lucky Event Issue


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Weak-Form Tests

  • Serial Correlation

  • Momentum

  • Returns over Long Horizons


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Predictors of Broad Market Returns

  • Fama and French

    • Aggregate returns are higher with higher dividend ratios

  • Campbell and Shiller

    • Earnings yield can predict market returns

  • Keim and Stambaugh

    • Bond spreads can predict market returns


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Anomalies

  • P/E Effect

  • Small Firm Effect (January Effect)

  • Neglected Firm

  • Book-to-Market Effects

  • Post-Earnings Announcement Drift


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Returns in Excess of Risk-Free Rate and in excess of the Security Market Line for 10 Size-Based Portfolios, 1926 – 2005


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Average Monthly Returns as a Function of the Book-To Market Ratio, 1963 – 2004


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Cumulative Abnormal Returns in Response to Earnings Announcements


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Mutual Fund Performance

  • Some evidence of persistent positive and negative performance.

  • Potential measurement error for benchmark returns.

    • Style changes

    • May be risk premiums


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Persistence of Mutual Fund Performance


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Behavioral Finance

  • Investors Do Not Always Process Information Correctly

  • Investors Often Make Inconsistent or Systematically Suboptimal Decisions


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Behavioral Biases

  • Framing

    • Decisions seem to be affected by how choices are framed – page 398

  • Mental Accounting

    • A special form of framing in which people segregate certain decisions

  • Regret Avoidance

    • Individuals would have more regrets when their decisions are more unconventional

  • Prospect Theory

    • Traders become risk seeking after they lose money


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Prospect Theory Graphs


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Limits to Arbitrage

  • Fundamental Risk

  • Implementation Costs

  • Model Risk


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Limits to Arbitrage and the Law of One Price

  • Siamese Twin Companies

  • Equity Carve-outs

  • Closed-End Funds


  • Login