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Serial Correlation and Market Efficiency – Price Momentum and Earnings Momentum

Serial Correlation and Market Efficiency – Price Momentum and Earnings Momentum. Economics 437. Definition of Market Efficiency (Shiller)……………once again. where. Implications of EMH (“Market Efficiency”). Stock prices should not be “serially correlated” There should no “mean reversion”

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Serial Correlation and Market Efficiency – Price Momentum and Earnings Momentum

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  1. Serial Correlation and Market Efficiency – Price Momentum and Earnings Momentum Economics 437

  2. Definition of Market Efficiency (Shiller)……………once again where

  3. Implications of EMH (“Market Efficiency”) • Stock prices should not be “serially correlated” • There should no “mean reversion” • There should be no “earnings momentum” • Or “stock price momentum” • Or “delayed reaction to news” • In general, no predictability of prices

  4. The issue of pricing market risk Recall CAPM: E[Ri] = Rf + β {E[RM] – Rf} Β is a “risk factor”…….are there others Regression against risk factors: R = α + β1X1 + β2 X2 +….. Βn Xn…………….

  5. Over and under reaction • De Bondt & Thaler • Over reaction to cumulation of (good, bad) news (leads to “mean reversion”) • Jegadeesh & Titman • Under reaction to single item of (good, bad) news (leads to “earnings momentum,” “price momentum”

  6. Sadka “Role of Liquidity Risk • Liquidity proxied by “price impact” • Variable permanent • Fixed transitory • Conclusion • Liquidity is a risk factor that can explain • Good news momentum • Earnings momentum

  7. Chordia and Shivakumar “Earnings and Price Momentum” • Compares the PMN to the WML portfolios • PMN explains most of the WML gains • PMN relates to macroeconomic activity

  8. Kathari, Lewellen, Warner “Stock Returns, Aggregate Earnings Surprises and Behavioral Finance” • Aggregate surprises do not provide momentum • Correlated with interest rate increases • Offset by interest rate increasses • Consistent with momentum at the firm level • Results are inconsistent with models that predict that rates and cash flows should move in opposite directions

  9. End

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