ADMS 3531 Chapter 8 Study Sheet.docx

ADMS 3531 Chapter 8 Study Sheet.docx - ADMS 3531 Chapter 8...

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ADMS 3531 Chapter 8 Study Sheet The Efficient market hypothesis (EMH) is a theory that asserts: As a practical matter, the major financial markets reflect all relevant information at a given time. Market efficiency research examines the relationship between stock prices and available information. The important research question : is it possible for investors to “beat the market?” Prediction of the EMH theory: if a market is efficient, it is not possible to “beat the market” (except by luck). The excess return on an investment is the return in excess of that earned by other investments that have the same risk. “Beating the market” means consistently earning a positive excess return . Three Economic Forces that can lead to Market Efficiency Investors use their information in a rational manner. Rational investors do not systematically overvalue or undervalue financial assets. If every investor always makes perfectly rational investment decisions, it would be very difficult to earn an excess return. There are independent deviations from rationality. Suppose that many investors are irrational. The net effect might be that these investors cancel each other out. So, irrationality is just noise that is diversified away. What is important here is that irrational investors have different beliefs. Arbitrageurs exist. Suppose collective irrationality does not balance out. Suppose there are some well-capitalized, intelligent, and rational investors. If rational traders dominate irrational traders, the market will still be efficient. Forms of Market Efficiency A Weak-form Efficient Market is one in which past prices and volume figures are of no use in beating the market. If so, then technical analysis is of little use.
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  • Winter '10
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