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Sess16 new - Lecture 16: Market Efficiency Reading: RWJ...

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Fin3715 – Fall 07 – Kayhan 1 Lecture 16: Market Efficiency Reading: RWJ Chapter 12 Outline : Market efficiency Definitions Anomalies Implications for financial managers
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Fin3715 – Fall 07 – Kayhan 2 What Do We Mean by “Efficient Market”? Prices reflect information Changes in prices are due to changes in information (i.e., news) Returns are unpredictable News is by definition unpredictable No one can consistently earn excess profits Investors act quickly to trade upon information until benefits=costs
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Fin3715 – Fall 07 – Kayhan 3 Rationale for Efficient Markets, no. 1 Investors are rational and value each security based on its fundamental value: the net present value of its expected future cash flows, discounted according to its risk characteristics. When new information changes expectations about the future cash flows or risk characteristics of a security, investors update their assessment of fundamental value and quickly bid the price of each security up or down accordingly.
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Fin3715 – Fall 07 – Kayhan 4 Rationale for Efficient Markets, no. 2 Not all investors are rational, but those that aren’t trade somewhat randomly (i.e., not all using the same investment strategy). In aggregate these “irrational” trades tend to cancel one another out, and prices are set as before by the rational investors that do exist in the market.
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This note was uploaded on 05/06/2008 for the course FIN 3715 taught by Professor Stephens during the Spring '08 term at LSU.

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Sess16 new - Lecture 16: Market Efficiency Reading: RWJ...

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