The Efficient Market Hypothesis

1. The Efficient Market Hypothesis

2. Efficient Market Hypothesis (EMH) • Do security prices reflect information ? • Why look at market efficiency • Implications for business and corporate finance • Implications for investment

3. Forms of the EMH • Weak • Semi-strong • Strong

4. 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

5. Random Walk Hypothesis • Why are price changes random? • Prices react to information • Flow of information is random • Therefore, price changes are random

6. Random Walk with Positive Trend Security Prices Time Irwin/McGraw-Hill 9-4 • The McGraw-Hill Companies, Inc., 1998

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

8. Returns Over Time -t 0 +t Announcement Date Irwin/McGraw-Hill 9-13 • The McGraw-Hill Companies, Inc., 1998

9. What Does the Evidence Show? • Technical Analysis • Fundamental Analysis • Anomalies Exist

10. Anomalies • Small Firm Effect (January Effect) • Neglected Firm • Market to Book Ratios • Reversals • Value Line Enigma • Post-Earnings Announcement Drift • Higher Level Correlation in Security Prices

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

12. Implications of Efficiency for Active or Passive Management • Active Management • Security analysis • Timing • Passive Management • Buy and Hold • Index Funds

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