Efficient versus Inefficient Market

1. 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

2. Cumulative Abnormal Returns Around Takeover Attempts: Target Companies

3. Stock Price Reaction to CNBC Reports

4. 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

5. Forms of the EMH • Weak • Semi-strong • Strong • See page 361.

6. 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

7. 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

8. Active or Passive Management • Active Management • Security analysis • Timing • Passive Management • Buy and Hold • Index Funds

9. Market Efficiency & Portfolio Management Even if the market is efficient a role exists for portfolio management: • Appropriate risk level • Tax considerations • Other considerations

10. Empirical Tests of Market Efficiency • Event studies • Assessing performance of professional managers • Testing some trading rule

11. Issues in Examining the Results • Magnitude Issue • Selection Bias Issue: investing in small stocks • Lucky Event Issue

12. Weak-Form Tests • Serial Correlation • Momentum • Returns over Long Horizons

13. 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

14. Anomalies • P/E Effect • Small Firm Effect (January Effect) • Neglected Firm • Book-to-Market Effects • Post-Earnings Announcement Drift

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

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

17. Cumulative Abnormal Returns in Response to Earnings Announcements

18. Mutual Fund Performance • Some evidence of persistent positive and negative performance. • Potential measurement error for benchmark returns. • Style changes • May be risk premiums

19. Persistence of Mutual Fund Performance

20. Behavioral Finance • Investors Do Not Always Process Information Correctly • Investors Often Make Inconsistent or Systematically Suboptimal Decisions

21. 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

22. Prospect Theory Graphs

23. Limits to Arbitrage • Fundamental Risk • Implementation Costs • Model Risk

24. Limits to Arbitrage and the Law of One Price • Siamese Twin Companies • Equity Carve-outs • Closed-End Funds