efficient markets n.
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Efficient Markets

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  1. Efficient Markets

  2. Class Announcements • Research Paper Part I due January 30th (today) • Assignment #4 due February 3rd ; available on-line • Assignment #5 due February 10th; available on-line • WIB Society Session: A Conversational with Successful Business Women, February 3, SCHW 7-9:00pm • Please advise mmoxner@stfx.ca of interest in Accounting Case Competition held March 6-7th (Halifax) by 5:00pm January 31, 2014

  3. Class Objectives • The context of the capital markets • The concept of an efficient market and its three forms of efficiency • Capital Asset Pricing Model (CAPM) as a means of valuing assets

  4. Capital Markets • Capital markets are long term markets which consist of securities having maturities greater than one year • The capital markets are a means of allocating the available capital to the most efficient users • Competitors for that capital are companies, domestic and international, government, provincial, municipal and federal

  5. Market Efficiency • “An efficient securities market is one where the prices of securities traded on that market at all times fully reflect all information that is publicly known about those securities.” (p. 100) • Investors are continuously revising their subjective state probabilities as information is received. • Different investors will react to the same information differently even though they all proceed rationally. • The process by which prices in the capital market do this is complex and not fully understood.

  6. Market Efficiency • Investors adjust their state probabilities for” • Economy wide factors • State of global economy • Inflation rates • Accounting Information • Income - Annual and quarterly reports • Industry Specific Information • Price of Gold • Firm specific information • http://www.theglobeandmail.com/globe-investor/markets/stocks/summary/?q=ABX-T

  7. Market Efficiency • Markets are efficient when • (1) prices adjust rapidly to new information • (2) there is a continuous market in prices • (3) the market can absorb large dollar amounts of securities without price destabilization • Informed investors will move quickly upon receipt of new information • On average the market uses all the information provided. • Market efficiency is a relative not absolute term

  8. Market Efficiency • There are 3 forms: • Weak form: • all past information is included in the price • Semi-strong form: • all public and past information is included in the price • Strong form: • all private, public and past information is included in the price • “An efficient securities market is one where the prices of securities traded on that market at all times fully reflect all information that is publicly known about those securities.” (p. 100)

  9. Market Efficiency: Implications • Efficiency implications for financial accounting • Content not form of disclosure is valued by the market • Accounting information is only one source of information used by investors and will survive if relevant. • Mechanisms must exist to enable communication of information (information asymmetry) • Our interest is in the characteristics of the market prices of securities traded in the market and how these prices are affected by new information. • Accounting is a mechanism to enable communication – reduce information asymmetry

  10. Market Efficiency: Information Asymmetry • Securities markets are subject to asymmetry problems • Frequently one type of participant in the market will know something about the asset being traded that another type of participant does not know. • Insiders are attracted by opportunities which are adverse to the interest of investors. • Two types of information asymmetry : • 1)Adverse selection – e.g. insider trading • 2) Moral hazard – e.g. shirking

  11. Market Efficiency: Implications

  12. Market Efficiency: Information Asymmetry • Social implications are associated with information asymmetry • Security prices do not reflect fundamental value • Allocation of scarce capital • Cost of capital • Countries with more firm-specific information incorporated into share price enjoy greater capital allocation efficiency • Incentives and Penalty Mechanisms • Signaling is one mechanism • Full disclosure

  13. Market Efficiency: Asset Pricing • Security analysis assumed that the essence of investing was to determine the intrinsic value of a security • While the market price of a security can determine on occasion from its intrinsic value over time it will move back to this value • Valuations: • 1) Dividend discount model – intrinsic price is the discounted value of this stream of expected future dividends P=D/(r-g) • 2) Capital Asset Pricing Model (CAPM) • 3) Technical analysis – plot of past prices

  14. Capital Asset Pricing Model • CAPM : in an efficient market the risk premium on each stock would be proportional to the risk premium on the entire market where the constant of proportionality (beta) is related to the covariance of the individual stock’s return with that of the market. • Uses: • 1) Price depends on investor expectation • 2) Allows for separation of returns • 3) Provides convenient way to estimate Beta.

  15. Capital Asset Pricing Model • CAPM • Rjt = a+ βj(RMt) + e • Only firm-specific component is ßj • Research can obtain past data on Rjt and RMt and use regression analysis to estimate the coefficient of the model • Abnormal return is the rate of return on firm j’s share for day after removing the influence of market wide factors. • A positive abnormal share return constitute evident that investor are reacting favorably to unexpected good news in earning

  16. Capital Asset Pricing Model

  17. Class Objectives - Revisited • The context of the capital markets • The concept of an efficient market and its three forms of efficiency • Capital Asset Pricing Model (CAPM) as a means of valuing assets

  18. Assignment #2 • Average: 1.54/2.5 or 62% • Hi: 2.15/2.5 • Lo: 0.85/2.5 • Comments: • Support conclusion with evidence • Use language from accounting theory to make your point (e.g., information asymmetry) • Improve flow of discussion • Avoid casual or conversational language • Do not end sentence or phrase in a preposition