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Chapter 12. The Efficient Market Hypothesis. Random Walk and the EMH. Random Walk - stock prices are random Actually submartingale Expected price is positive over time Positive trend and random about the trend. Random Walk with Positive Trend. Security Prices. Time.

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chapter 12

Chapter 12

The Efficient Market Hypothesis

random walk and the emh
Random Walk and the EMH
  • Random Walk - stock prices are random
    • Actually submartingale
      • Expected price is positive over time
      • Positive trend and random about the trend
random price changes
Random Price Changes
  • Why are price changes random?
    • Prices react to information
    • Flow of information is random
    • Therefore, price changes are random
emh and competition
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
forms of the emh
Forms of the EMH
  • Weak
  • Semi-strong
  • Strong
types of stock analysis
Types of Stock Analysis
  • Technical Analysis - using prices and volume information to predict future prices
    • Weak form efficiency & technical analysis
  • Fundamental Analysis - using economic and accounting information to predict stock prices
    • Semi strong form efficiency & fundamental analysis
implications of efficiency for active or passive management
Implications of Efficiency for Active or Passive Management
  • Active Management
    • Security analysis
    • Timing
  • Passive Management
    • Buy and Hold
    • Index Funds
market efficiency and portfolio management
Market Efficiency and Portfolio Management

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

  • Appropriate risk level
  • Tax considerations
  • Other considerations
tests of semi strong form anomalies
Tests of Semi-strong Form: Anomalies
  • Small Firm Effect (January Effect)
  • Neglected Firm
  • Market to Book Ratios
  • Post-Earnings Announcement Drift
implications of test results
Implications of Test Results
  • Risk Premiums or market inefficiencies
  • Anomalies or data mining
  • Behavioral Interpretation
    • Inefficiencies exist
    • Caused by human behavior
behavioral possibilities
Behavioral Possibilities
  • Forecasting Errors
  • Overconfidence
  • Regret avoidance
  • Framing and mental accounting errors
When the market risk premium declines, stock prices will ________.A) riseB) fallC) recoverD) have excess volatilityAnswer B

According to the efficient market hypothesis, __________.A) positive alphas on stocks will disappear quicklyB) low beta stocks are consistently underpricedC) high beta stocks are consistently overpricedD) None of the above answers is correctAnswer A


Research on the strong form of market efficiency shows that ________ are generally able to achieve superior returns.A) members of the SECB) the majority of professional mutual fund managersC) corporate insidersD) stock brokersAnswer C


The ______________ of the efficient market hypothesis suggests that there is little or nothing to be gained from studying past stock price trends.A) weak formB) semi-weak formC) semi-strong formD) strong form Answer A


Which one of the following forms of market efficiency is violated if you can earn excess return by buying stocks of firms which make merger announcements?A) Weak form.B) Semi-weak form.C) Semi-strong form.D) Strong form.Answer C


The efficient market hypothesis suggests that ___________.A) no investors can earn a positive return at any point in time.B) no investors can earn a positive return persistently over time.C) no investors can earn an excess return at any point in time.D) no investors can earn an excess return persistently over timeAnswer D


The January effect of small firms is greatest ________.A) in leap yearsB) in presidential election yearsC) late in the monthD) early in the monthAnswer D


Which of the following has(have) been considered market anomalies?A) the reversal effectB) the book-to-market effectC) the small-firm January effectD) All of the above have been considered market anomalies Answer D


Empirical evidence supporting the semi-strong form market efficiency suggests that investors should follow ____________ investment strategy.A) a passiveB) an activeC) a conservativeD) an aggressiveAnswer A