Efficient Market Investment Value Market Price

1. Efficient MarketInvestment ValueMarket Price

2. Efficiency in Economics • It has several quite distinct meanings. For example: Allocative efficiency It is concerned with the optimal distribution of scarce resources among individuals in the economy. Efficient portfolio It is one with the highest expected return for a given level of risk. Efficient marketis one in which information is rapidly disseminated and reflected in prices.

3. Definition In finance, the efficient-market hypothesis (EMH) state that financial markets are "informationally efficient". i.e. one cannot consistently achieve returns in excess of average market returns. • An efficient market is one in which securities prices reflect all available information. • This means that every security traded in the market is correctly valued given the available information.

4. Eugene Francis "Gene" Fama (born February 14, 1939) is an American economist, known for his work on portfolio theory and asset pricing, both theoretical and empirical. He is currently Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business

5. Experts view • Fama(1969)a market that: “adjustsrapidly to new information” • Fama (1998):the hypothesis that: “prices fully reflect available information” ‘It is the simple market efficiency story where; --The expected value of abnormal returns is zero, but --Chance generates deviations from zero (anomalies) in both directions.’

6. Anomalies Def: “Some irregular, abnormal, strange, unexpected or inconsistent features of something” Deviation from the normal or usual order, type, etc.; irregularity

7. Reaction of Stock Price to New Information in Efficient Markets Stock Price Overreaction to “good news” with reversion Delayed response to “good news” Efficient market response to “good news” -30 -20 -10 0 +10 +20 +30 Days before (-) and after (+) announcement

8. Reaction of Stock Price to New Information in Efficient Markets Efficient market response to “bad news” Stock Price Delayed response to “bad news” -30 -20 -10 0 +10 +20 +30 Overreaction to “bad news” with reversion Days before (-) and after (+) announcement

9. The idea of the Efficient Market Hypothesis • Markets and participants are at all times on a level playing field with respect to information. • As such, no one person, trader, investor, speculator, whatever…has an edge over anyone else and thus, • Nobody should ever be able to “beat the market” over an extended period of time for any reason other than just a luck.

10. There are three types • Weak • semi-strong • Strong

11. The EMH Graphically All historical prices and returns • In this diagram, the circles represent the amount of information that each form of the EMH includes. • Note that the weak form covers the least amount of information, and the strong form covers all information. • Also note that each successive form includes the previous ones. All information, public and private All public information

12. Weak form of efficiency • It claims that all past prices of a stock are reflected in today's stock price. • Therefore, technical analysis cannot be used to predictand beat a market. • It states that fundamental analysis can be used to identify stocks that are undervalued and overvalued. • Therefore, keen investors looking for profitable companies can earn profits byresearching financial statements.

13. FAILURES OF TECHNICAL ANALYSISBelieving-is-Seeing Problem • Eager to believe in the possibility of beating the market, investors sometimes “see” results that do not really exist. • There is no robust (conclusive) evidence that technical trading rules can enhance investor or trader profits.

14. Semi-strong It implies that: • All public informationis calculated into a stock's current share price. • Fundamental nor technical analysis cannot be used to achieve superior gains. • It suggests that only information that is not publicly available can benefit investors seeking to earn abnormal returns on investments. • Semi-strong EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information.

15. Public vs. Private Information • Stock Market Information: stock price and trading volume figures • Public Information: freely shared information • Insider Information: information within a firm

16. Strong • Here share prices reflect all information, public and private, and no one can earn excess returns. • If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. • To test for strong-form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. • Even if some money managers are consistently observed to beat the market • No rejection even of strong-form efficiency follows: with hundreds of thousands of fund managers worldwide, even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers.

17. Strong EMH additionally claims that prices instantly reflect even hidden or "insider" information. • There is evidence for and against the weak and semi-strong EMHs, while there is powerful evidence against strong EMH

18. Impossible • Grossman and Stiglitz (1980) argued that because information is costly, • Prices cannot perfectly reflect the information which is available • Since if it did, those who spent resources to obtain it would receive no compensation • Therefore, leading to the conclusion that an informationally efficient market is impossible.

19. OBSERVATIONS ABOUT PERFRCTLY EFFICIENT MARKET • Investors should expect to make a fair (or normal return) on their investment and no more Investors looking for mispriced securities -using technical analysis -using fundamental analysis • They will not be fruitful • They cannot earn abnormal profit • Only some may earn because of luck

20. 2. Markets will be efficient only if enough investors believe that they are not efficient Investors who analyze securities carefully believe that markets are perfectly efficient So Everyone realize - Nothing is expected to be gained - Therefore, securities would not react immediately - Would respond more slowly Thus markets becomes inefficient if investor believe them to be efficient

21. 3. Publically known investment strategies cannot be expected to generate abnormal returns If past strategy generated abnormal profits --It was then revealed to public (Now usefulness of strategy will be destroyed) Investors who know the strategy will try to capitalize on it --In return it will force the prices to change The action of investors will eliminate effectiveness of strategy

22. 4. Some investors will display impressive performance records Investors performance is due to chance Eg: In a model: -- Half the period of year prices are expected to go up -- Half the period of year prices are expected to go down On the basis of such forecast --some investors who believe the prices to go up will buy --some investors who believe the prices to go down will sell Now --some will be right --some will be wrong Benefited investors are due to luck not the skills Therefore, unreliable evidences about success are misleading

23. 5. Professional investors should fare no better in picking securities than ordinary investors Prices always reflect investment value --Therefore, search for mispriced securities is of no use Investors may be professional or ordinary --Their gains or return will be same

24. 6. Past performance is not an indicator of future performance Investors who did well in past are not likely to do better in future --It was just a luck Investors who did poor in past are not likely to do poor in future --It was just a misfortune