Note-6 - EMH & Bond Pricing-1

Note-6 - EMH & Bond Pricing-1 - Economics 106V...

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Economics 106V Investments : Lecture Note-6 Daisuke Miyakawa UCLA Department of Economics July 11, 2008 6th lecture covers the following items over two topics: First part covers (1) the main message of e¢ cient market hypothesis (EMH), (2) the three forms of EMH, (3) its practical implication, and the second part covers (4) yield to maturity of a bond, (5) holding period return of a bond, and (6) zero coupon bond price. After discussing those items, we solve some exercise problems. 1 Market E¢ ciency 1.1 Motivating Questions information available in the market (i.e., Is the market e¢ cient) ? (ii) Why do we need to care about the 1.2 Main Message of E¢ cient Market Hypothesis (EMH) The main message of EMH is the following: First of all, stock prices fully and accurately re±ect publicly available information. This is because (i) once information becomes available, market participants analyze it, and (ii) competition assures prices re±ect information. You can see that the availability of information and the competition are the driving forces of EMH. Figure-1: A Process of Return Figure-1 illustrates this hypothesis. This is a time-series plot of the price response of a sample of 194 1
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the return from the trend and the horizontal axis corresponds to the time (0 is the timing of the announce- ment). Roughly speaking, after the announcement, there is almost no additional abnormal return. This information. But still, there is something weird on this graph. For example, the plot seems to have an upward slope even before the timing of the announcement. In order to understand these feature in the data, we need to construct the EMH more precisely. 1.3 Three Forms of the EMH Corresponding to the types of information sets, there are three types of EMH. First, the weak form of the e¢ cient markets hypothesis (EMH) states that stock prices immediately nothing about past values of prices helps forecast for the future price change. For example, technicians attempt to predict future stock prices based on historic stock price movements. Thus, if the weak form of the EMH holds, the work of the technician is of no value. Second, the semi-strong form of the EMH states that stock prices include all public information. This form
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Note-6 - EMH & Bond Pricing-1 - Economics 106V...

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