Topic 8. MarketEfficiency.pptx

Topic 8. MarketEfficiency.pptx - BX2031:03 Personal...

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BX2031:03 Personal Portfolio Management Lecture Eight – Market Efficiency 1
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Learning objectives After completion of this chapter you should be able to: understand the notion of an efficient capital market appreciate the different types of efficiency and how they apply to financial markets understand the role of information in setting security prices discuss the empirical evidence surrounding the concept of market efficiency understand the implications of empirical studies for practical investment analysis comprehend the debate surrounding market efficiency, particularly the controversy over the era of New Finance present mounting a logical, referenced and reasoned argument as to whether or not markets are efficient. 2
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Chapter outline 1 Introduction 2 Issues of efficiency 3 Efficiency and past price information 4 Efficiency and accounting information 5 Efficiency and economic information 6 The pricing of firm size 7 Growth shares versus value shares 8 Efficiency and capital restructuring 9 Efficiency and volatility 10 Efficiency and private information 11 Implications of efficiency 12 Summary 3
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1 Introduction The concept of market efficiency is probably one of the most debated and contested issues in modern investment theory. Efficiency has many definitions such as allocation, and processing of transactions. Informational efficiency is where the current prices of securities fully reflect available information about that security. In an efficient market, new information is incorporated into prices in an instantaneous and unbiased manner. Hence, knowledge of that information set cannot be used to consistently earn excess returns. The market can be both partially efficient and partially inefficient. The polar cases of complete inefficiency or efficiency are unlikely. 4
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1 Introduction Why should we expect efficiency to occur? That is, what makes investors want to trade until prices reflect information? This requires zero cost for information and trading Obviously these requirements are not met. Can efficiency be achieved in imperfect markets? Views on efficiency Ball (1995) views market efficiency as an exercise in cost–benefit analysis. In an efficient market, the marginal cost of obtaining and acting on information should not exceed the marginal benefit derived from such actions. Jensen (1978) argues that for a market to be truly inefficient, any inefficiencies must give rise to profit-making opportunities. Thus, inefficiencies that are not economically exploitable can still be consistent with an efficient market. 5
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2 Issues of efficiency Recall definition of efficiency – prices fully reflect available information.
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