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FNCE100_PS5(market efficiency

FNCE100_PS5(market efficiency - University of Pennsylvania...

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University of Pennsylvania The Wharton School FNCE 100 A. Craig MacKinlay PROBLEM SET #5 Fall Term 2005 Market Efficiency 1. Money manager Robert J. Betaman of Betaman-Rubin Associates has shown an un- canny ability to beat the market (i.e., to earn consistently abnormally high returns after adjustments for risk, transactions costs, etc.). Until recently, other investors’ attempts to learn Betaman’s secrets have failed totally. However, one year ago, Be- taman revealed his secret formula for investment success in an interview published in the business section of The National Enquirer . Over the last year, Betaman has not earned abnormally high returns using his formula. Briefly explain why. 2. -12 -6 0 6 12 time in months relative to event month -20% 0 CAR t • • The above diagram represents the (hypothetical) results of a study of the behavior of stock prices of firms that lost antitrust cases. (Included are all firms that lost the initial court decision, even if the ruling was later overturned on appeal.) Is the diagram consistent with market efficiency? Why or why not? 3. Consider an efficient capital market. If a particular economic variable which influ- ences a firm’s profits is predictable, would you expect price changes in the stock to be predictable? 4. “If the Efficient Market Hypothesis is true, the pension fund manager might as well select a portfolio with the financial pages of the WSJ, a thumbtack, a wall and a dart.” Explain why this is not so. 55
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5. Fama-Fisher-Jensen-Roll’s observation that, on the average, firms which split their stock earn abnormal returns prior to the split announcement: (a) is evidence in favor of the semi-strong form of the efficient market hypothesis (SSF-EMH); (b) is evidence against the SSF-EMH; (c) neither supports nor refutes the SSF-EMH; (d) is evidence that firms which split their stock have done well in the period prior to the split announcement; (e) (a) and (d); (f) (b) and (d); (g) (c) and (d); (h) none of the above. Select one. Explain. 6. A respected security analyst has analyzed annual reports and 10-K reports in detail and adjusted firms’ liabilities to reflect unfunded pension benefits. He has found that this adjustment would drastically affect the book value of equity for some corporations. On the day that he publicly reported his results, the stock prices of the corporations for which he labeled the reported book value as “substantially overstated” did not have price changes which could not be explained by market movements, however. Fur- thermore, in the month after the announcement, on average there were no statistically significant abnormal returns for these companies, once the returns were adjusted for risk. This sequence of events is evidence supporting:
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FNCE100_PS5(market efficiency - University of Pennsylvania...

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