Efficient Capital Markets - By Reilly and Brown Lecturer Dr...

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By Reilly and Brown Lecturer: Dr. Ruei-Shian Wu
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Efficient Capital Markets Questions to be answered: What is meant by the concept that capital markets are efficient? Why should capital markets be efficient? What are the specific factors that contribute to an efficient market? Given the overall efficient market hypothesis, what are the three sub-hypotheses and what are the implications of each? 2
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Efficient Capital Markets How do you test the weak-form efficient market hypothesis (EMH) and what are the results of the tests? How do you test the semistrong-form EMH and what are the test results? How do you test the strong-form EMH and what are the test results? For each set of tests, which results support the hypothesis and which results indicate an anomaly related to the hypothesis? 3
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Efficient Capital Markets What are the implications of the results for Technical analysis? Fundamental analysis? Portfolio managers with superior analysts? Portfolio managers with inferior analysts? 4
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Efficient Capital Markets In an efficient capital market, security prices adjust rapidly to the arrival of new information, therefore the current prices of securities reflect all information about the security Whether markets are efficient has been extensively researched and remains controversial 5
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Why Should Capital Markets Be Efficient? The premises of an efficient market A large number of competing profit- maximizing participants analyze and value securities, each independently of the others New information regarding securities comes to the market in a random fashion Profit-maximizing investors adjust security prices rapidly to reflect the effect of new information Conclusion: the expected returns implicit in the current price of a security should reflect its risk 6
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Alternative Efficient Market Hypotheses (EMH) Random Walk Hypothesis changes in security prices occur randomly Fair Game Model – current market price reflect all available information about a security and the expected return based upon this price is consistent with its risk Efficient Market Hypothesis (EMH) – divided into three sub-hypotheses depending on the information set involved 7
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Efficient Market Hypotheses (EMH) Weak-Form EMH - prices reflect all security-market information Semistrong-form EMH - prices reflect all public information Strong-form EMH - prices reflect all public and private information 8
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Weak-Form EMH Current prices reflect all security- market information, including the historical sequence of prices, rates of return, trading volume data, and other market-generated information This implies that past rates of return and other market data should have no relationship with future rates of return 9
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Semistrong-Form EMH Current security prices reflect all public information, including market and non-market information This implies that decisions made on new information after it is public should not lead to above-average risk-adjusted profits from those transactions 10
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  • Fall '15
  • Wu
  • Financial Markets, EMH, Efficient-market hypothesis, semistrong-form EMH

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