I wish … I could understand how monkeys can pick up stocks in an efficient market!!!

1. I wish … I could understand how monkeys can pick up stocks in an efficient market!!!

2. It is interesting to understand the concept of Efficient Markets. Now, I think I am getting about efficient markets.

3. A Debate... In the last class, we started with the debate on Efficient Markets!!!!!!!! Stock markets are EFFICIENT!!!

4. First, we put argument FOR THE EFFICIENT MARKETS Yes!!! Stock markets are efficient.

5. EFFICIENT MARKET ... • … … implies that as new information becomes available, it is quickly analyzed by the market, and all necessary price adjustments occur rapidly. • In an efficient security market, prices are determined so as to reflect all available economic information.

6. A theory that puts forward the idea and a framework related to Efficient Security Market is popularly known as EFFICIENT MARKET HYPOTHESIS.

7. EFFICIENT MARKETS ARE HAVING DIFFERENT SHADES. • Fama has defined the following three forms of efficiency in a security market: • WEAK FORM OF EMH • SEMI - STRONG FORM OF EMH • STRONG FORM OF EMH

8. WEAK FORM MARKET EFFICIENCY • A weak form efficient market hypothesis assumes that current share prices reflect all stock market information including the historical sequence of prices, price changes, trading volume, and any other market information. • This hypothesis implies: • there is no relation between past prices and future prices • no trading rule that depends upon past share prices can predict future share prices • past prices do not provide any information that can be used to outperform the market • share prices follow random walk

9. Implication of Weak Form of EMH for Technical Analysis is that it is a fruitless exercise...!!!!

10. SEMI-STRONG FORM MARKET EFFICIENCY • The Semi-Strong form efficient market hypothesis asserts that security prices adjust rapidly to the release of all new public information. • It means that the share prices reflect all public information. • This hypothesis implies that - • it encompasses weak form hypothesis. • If an investor acts on the basis of an information after it has become public, then he can not derive above average profit. • The prices adjust either before the announcement or during the announcement but notafter the announcement.

11. Implication of Semi-Strong Form of EMH for Fundamental Analysis is that it can not earn abnormal profits...!!!!

12. STRONG FORM MARKET EFFICIENCY • Strong Form Efficient Market Hypothesis contends that stock prices reflect all information - public or private. • It implies that no group of investors has a monopolistic access to information relevant to formation of prices and thus, can not exploit it. • None can consistently derive above average profits. • It encompasses both weak and Semi-strong form of efficient markets. • It requires not only efficient markets but also perfect markets where all information is available to all investors.

13. Efficient Market Hypothesis: A summary • Weak EMH, assumes that all historical information is reflected in security prices. • Semi-strong EMH, assumes that all public information is reflected in security prices. • Strong EMH, assumes that all information is reflected in security prices

14. Efficient Market Hypothesis: A summary (continued…)

15. If the markets are efficient, then simply throw a dart and select a security !!! But, will it be so simple???

16. What kind of investment strategy under Efficient Markets…? • Two types of investment strategies are broadly identified: • ACTIVE; and • PASSIVE. • If the market is efficient, then the PASSIVE Investment Strategy will be relevant. • One may use INDEX-FUND for investment purposes.

17. But, still an investment manager has a role to play even in an efficient market. • Follow Passive Investment Strategies but still perform actively the following tasks- • Ensure the correct amount of diversification of the portfolio managed. • Maintain the desired level of risk of the portfolio. • Try to minimize the transaction costs. • Try to seek tax advantages. • Innovate

18. Now, we put argumentAGAINST THE EFFICIENT MARKETS Yes!!! Stock markets are not efficient.

19. Evidence against EFFICIENT MARKETS…. • There are certain evidences available which go against the concept of EMH and they are the sources of PUZZLING those who believe strongly in EMH. • Believers of EMH say them as anomaliesand hence, we shall be calling them aspuzzling anomalies.

20. PUZZLING ANOMALIES QUESTION EMH? • These anomalies can be grouped under the following heads: 1. SEASONAL ANOMALIES 2. EVENT ANOMALIES 3. FIRM ANOMALIES 4. ACCOUNTING ANOMALIES 5. MARKET ANOMALIES

21. SEASONAL ANOMALIES

22. SEASONAL ANOMALIES These anomalies are associated with the calendar or time. The following are some of the seasonal anomalies. a. January Effect b. Day-of-the-week Effect c. Time-of-the-day Effect

23. JANUARY EFFECT … • It is observed that the January Effect is tied to tax-loss selling at the end of the year. The hypothesis in this regard is that many people sell shares that have declined in price during the previous months to realize their capital losses so as to reduce the tax liability. And, the money realized is used to buy shares in the month of January. It is specially true for small-cap companies. • This effect is well documented by Jay R. Ritter in 1988 and he showed that the ratio of share purchases to sales of individual investors reaches an annual low at the end of December and an annual high at the beginning of January.

24. Day-of-the-Week Effect… • French (1980) originally observed that stock returns are higher on average on the last trading day of the week (Friday) and lower on the first (Monday). • After that, many studies document that the average return on Friday is abnormally high and the average return on Monday is abnormally low. This is known as the '' weekend effect'' or ''day-of-the week effect'' phenomenon. • Such an anomaly has also been observed even in India.

25. TIME-OF-THE-DAY EFFECT • On average, the market tends to be up in the first 45 minutes of trading and down in the last 15 minutes of trading.

26. EVENT ANOMALIES

27. EVENT ANOMALIES These anomalies are associated with some easily identified events. The following are some of the event anomalies. a.Insider trading effect b. Analysts’ recommendations effect

28. INSIDER TRADING EFFECT • On average, stocks with high volume of purchases from insider tend to rise in price.

29. ANALYSTS’ RECOMMENDATIONS EFFECT • On average, a stock that is highly recommended by analysts tends to drop in price.

30. FIRM ANOMALIES

31. FIRM ANOMALIES These anomalies are associated with firm-specific characteristics. The following are some of the firm anomalies. • Small firm (or Size) effect • Neglected firm effect • Institutional holding effect

32. SIZE EFFECT… • The Size Effect is also known as SMALL FIRM EFFECT. • Such an effect was originally documented by Rolf Banz in 1981 in US. • According to it, it was observed that the smallest-size firms portfolio outperforms the largest-size firms portfolio by an average of 4.3% annually even on a risk-adjusted basis. • Had there been an EFFICIENT STOCK MARKET, such anomalies could not exist.

33. NEGLECTED FIRM EFFECT • On average, stocks that are not closely followed by many analysts tend to yield higher returns than the ones that are.

34. INSTITUTIONAL HOLDING EFFECT • On average, stocks owned by only a few institutions tend to provide higher returns.

35. ACCOUNTING ANOMALIES

36. ACCOUNTING ANOMALIES These anomalies are associated with the release of accounting information. The following are some of the accounting anomalies. a. SmallP/E effect b. Earnings surprises effect c. Dividend yield

37. SMALL P/E EFFECT… • S. Basu (1977) discovered that portfolios of low Price/Earnings Ratio shares have higher returns than that of those portfolios having high P/E Ratio. • It was found that the P/E Ratio Effect holds up even if the returns are adjusted for portfolio beta. • Such an anomaly has been observed even in India.

38. EARNINGS SURPRISES EFFECT • Earnings surprise is a relatively large deviation from an earnings forecast. • It has been observed that on the average, the prices of stocks with higher than expected earnings announcements tend to continue to rise even after the announcement. • And, this leads to an anomaly.

39. DIVIDEND YIELD EFFECT • Researches have suggested that cash dividend yields have a positive but marginally significant effect on the market value of equity shares which means that on average, stocks with high dividend yield tends to outperform stocks with low dividend yield. • Cash dividend effects of such kind can be considered an anomaly in the efficient market theory.

40. MARKET ANOMALIES

41. MARKET ANOMALIES These anomalies are associated with the market behaviour and market psychology. The following are some of the market anomalies. • Book Value to Market Value Ratio Effect • Reversal Effect • Market Momentum Effect

42. BOOK VALUE TO MARKET VALUE RATIO EFFECT… • Fama and French (1992) showed that a powerful predictor of returns across securities is the ratio of the book value of the firm’s equity to the market value of equity. • Their research have shown that the decile with the highest book-to-market ratio had an average monthly return of 1.65% (over the period July 1963 through December 1990), while the lowest-ratio decile averaged only 0.72% per month. • It indicates that the share with higher book-value to market value ratio are relatively under-priced.

43. REVERSAL EFFECT • Debondt and Thaler (1985), and Chopra, Lakonishok and Ritter (1992) found through their researches strong tendencies for poorly performing stocks in one period to experience sizable reversals over the subsequent period, while the best-performing stocks in a given period tend to follow with poor performance in the following period. • In brief, researches have shown “REVERSAL EFFECT” in which losers rebound and winners fade back over a period of time which means it is a long-term tendency. • The Reversal Effect would imply that a contrarian investment strategy should be profitable. It is believed that such a Reversal Effect takes place because returns shows a strong tendency of mean reversal.

44. MARKET MOMENTUM EFFECT • Unlike the Reversal Effect, the Momentum Effect means a tendency in the markets that a ‘good share’ will continue to perform better while a ‘bad share’ will continue to perform badly. • Researchers have believed that the markets show a strong tendency of momentum over a short horizon of time. • Jegadeesh and Titmen (1993) showed using 3- to 12- months holding periods that stocks exhibit a momentum property in which good or bad recent performance continues. • Even studies in India show the momentum property in Indian shares.

45. What can we say at the end about the EFFICIENCY OF STOCK MARKETS??? • An overly doctrinaire belief in efficient market hypothesis can paralyze the investor and make it appear that no research effort can be justified. Such an extreme view is probably unwarranted. There are enough anomalies in the empirical evidence to justify the search for under-priced securities that clearly goes on……………………..

46. Finally…. WHAT HAPPENED TO MONKEYS…!!??

47. You’re Fired!