financial Week10Tutorial
EmilyLo
EfficientMarketHypothesis
A market is said to be efficient if asset
prices respond to relevant information
instantaneously and accurately
This implies:
- no one is able to make abnormal returns as prices
reflect all information available
- stock price movements are unpredictable follow a
random walk
ThreeformsofMarketEfficiency
Each versions differ by their notions of what is meant
by the term all available information
1. Weak Form
- stock prices already reflect all information that can
be derived by past trading data
- implies trend analysis is worthless
2. Semi Strong Form
- all publicly available information regarding the
prospects of a firm must be reflected in stock price
- in addition to past trading data, includes information
regarding the industry, economy and the firm
TestingtheWeakform
Evidence that supports the weak form:
Trading rules that result from technical analysis is
not profitable (Ball, 1978)
No serial correlation between daily returns over short
intervals
This supports that stock prices do not have predictable
patterns
Anomalies:
Negative serial correlation observed over long
intervals (Fama & French, 1988)
Portfolios containing the worst stocks in the past 5
Testingthesemistrongform
Evidence that supports the semi-strong form
(Jones et al, 1984):
Pre-announcement drift
- this reflects information leakage and prices are
responding to it
Immediate response to unexpected earnings
announcement in the right direction on the
announcement day
Anomalies:
Post-announcement drift continued after the
announcement day
Testingthestrongformefficiency
Trading on inside information is illegal, thus research
is based on examining the profitability of disclosed
trading on shares of corporate insiders (Rozeff &
Zaman, 1988)
Although corporate insiders on average earned
about 3% per year net of transaction costs on trading
their own stocks, the amount of abnormal return is
economically insignificant
Investors cannot make abnormal returns following
the actions of corporate insiders after the trades
were published indicating that the price of shares
reflect the information once published this
suggests semi-strong form
DQ1
Do you believe that the share market is weak
form efficient if you are a client of E-trade, an
online broker, and frequently use the free
technical analysis, to decided on your trading
strategies? Explain.
No
Believing in weak form means stock prices reflect
historical trading information so analysing such
information wont bring abnormal return
Technical analysis is based on analyzing historical
price and volume data of stock prices
Hence you do not believe in weak form efficiency as
DQ2
Do you believe that the share market is semistrong form efficient if you constantly call up
your broker to seek advice from his research
team for tips stocks? on Explain.
No.
Believing in Semi-strong form means share prices
have fully reflected publicly available information and
past information, thus fundamental analysis wont
bring abnormal return
Advice from his research team is based on
fundamental analyses which uses publicly available
information, such information incorporates the
DQ3
Suppose you work in the corporate advisory
section of a reputable merchant bank. Your role
is to give advice to clients on mergers and
acquisitions. Do you believe that the market is
strong form efficient if you share your knowledge
gathered from work with your parents-in-law
knowing that they will act upon your
information? Explain.
No.
Believing in strong form efficiency means that share
prices fully reflect private, publicly available and past
information.
DQ4
If the market is not weak form efficient, can you
say for sure that the market is also not semistrong form efficient?
Yes.
A semi-strong form efficient market implies that
share prices reflect publicly traded information in
addition to historical information.
If market is not weak form efficient, prices do not
reflect historical information and hence abnormal
return can be made out of it.
Since the market does not reflect historical
information, then semi-strong form cannot be
DQ5
If the market is not semi-strong form efficient,
can you say for sure that the market is also not
weak form efficient?
No.
Semi-strong form efficiency implies share prices
reflect publicly available information and historical
trades and volume data.
If market is not semi-strong form efficient, it can be
that the market is not reflecting publicly available
information such as macro-economic data or
industry specific information, or and not reflecting
historical trades and volume data.
MCQ1
Assume that a company announces an
unexpectedly large cash dividend to its
shareholders. In an efficient market without
information leakage, one might expect:
A. an abnormal price change at the announcement
B. an abnormal price increase before the
announcement
C. an abnormal price decrease after the
announcement
D. no abnormal price change before or after the
announcement
MCQ2
According to the EMH:
A. High beta stocks are consistently overpriced.
B. Low beta stocks are consistently overpriced.
C. Positive alphas on stocks will quickly disappear.
D. Negative alpha stocks consistently yield low
returns for arbitrageurs
MCQ3
Which of the following would be a viable way to
earn abnormally high trading profits if markets
are semi-strong form efficient?
A. Buy shares in companies with low P/E ratios
B. Buy shares in companies with recent aboveaverage price changes
C. Buy shares in companies with recent belowaverage price changes
D. Buy shares in companies for which you have
advance knowledge of an improvement in the
management team