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Chapter 12

Chapter 12. The Efficient Market Hypothesis. Random Walk and the EMH. Random Walk - stock prices are random Actually submartingale Expected price is positive over time Positive trend and random about the trend. Random Walk with Positive Trend. Security Prices. Time.

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Chapter 12

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  1. Chapter 12 The Efficient Market Hypothesis

  2. Random Walk and the EMH • Random Walk - stock prices are random • Actually submartingale • Expected price is positive over time • Positive trend and random about the trend

  3. Random Walk with Positive Trend Security Prices Time

  4. Random Price Changes • Why are price changes random? • Prices react to information • Flow of information is random • Therefore, price changes are random

  5. EMH and Competition • Stock prices fully and accurately reflect publicly available information • Once information becomes available, market participants analyze it • Competition assures prices reflect information

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

  7. 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

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

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

  10. Tests of Semi-strong Form: Anomalies • Small Firm Effect (January Effect) • Neglected Firm • Market to Book Ratios • Post-Earnings Announcement Drift

  11. Implications of Test Results • Risk Premiums or market inefficiencies • Anomalies or data mining • Behavioral Interpretation • Inefficiencies exist • Caused by human behavior

  12. Behavioral Possibilities • Forecasting Errors • Overconfidence • Regret avoidance • Framing and mental accounting errors

  13. When the market risk premium declines, stock prices will ________.A) riseB) fallC) recoverD) have excess volatilityAnswer B

  14. According to the efficient market hypothesis, __________.A) positive alphas on stocks will disappear quicklyB) low beta stocks are consistently underpricedC) high beta stocks are consistently overpricedD) None of the above answers is correctAnswer A

  15. Research on the strong form of market efficiency shows that ________ are generally able to achieve superior returns.A) members of the SECB) the majority of professional mutual fund managersC) corporate insidersD) stock brokersAnswer C

  16. The ______________ of the efficient market hypothesis suggests that there is little or nothing to be gained from studying past stock price trends.A) weak formB) semi-weak formC) semi-strong formD) strong form Answer A

  17. Which one of the following forms of market efficiency is violated if you can earn excess return by buying stocks of firms which make merger announcements?A) Weak form.B) Semi-weak form.C) Semi-strong form.D) Strong form.Answer C

  18. The efficient market hypothesis suggests that ___________.A) no investors can earn a positive return at any point in time.B) no investors can earn a positive return persistently over time.C) no investors can earn an excess return at any point in time.D) no investors can earn an excess return persistently over timeAnswer D

  19. The January effect of small firms is greatest ________.A) in leap yearsB) in presidential election yearsC) late in the monthD) early in the monthAnswer D

  20. Which of the following has(have) been considered market anomalies?A) the reversal effectB) the book-to-market effectC) the small-firm January effectD) All of the above have been considered market anomalies Answer D

  21. Empirical evidence supporting the semi-strong form market efficiency suggests that investors should follow ____________ investment strategy.A) a passiveB) an activeC) a conservativeD) an aggressiveAnswer A

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