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Unformatted text preview: 6/29/2009 1 THE FEDERAL RESERVE SYSTEM THE FEDERAL RESERVE SYSTEM JUNE 29 TH , 2009 Lauren Heller Econ 423, Financial Markets The Plan for Today b The Efficient Markets Hypothesis b Evidence against market efficiency b The Federal Reserve System b Origins b Structure b Central Bank Independence b According to the efficient markets hypothesis: 1. Expectations are optimal forecasts using all available information, And, 2. Prices reflect the true intrinsic value of securities b In an efficient capital market, one investment is as good as any other because the securities’ prices are correct. Recall from last time... Recall from last time… b Evidence in Favor of Market Efficiency 1. Investment analysts and mutual funds don't “beat” the market 2. Stock prices reflect publicly available info s Anticipated announcements don't affect stock price 3. Stock prices and exchange rates are close to a “random walk” 4. Technical analysis does not outperform market Evidence Contradicting Market Efficiency 1. The “Small Firm” Effect b Small firms tend to have abnormally high returns, even after accounting for increased risk. b Effect has diminished in recent years 2. The “January” Effect b Higher stock returns generally occur in January, even though this rise can be anticipated. b Possible explanation – tax incentives s Sell stocks in December, repurchase in January Evidence Contradicting Market Efficiency 3. Market Overreaction b Investors tend to overreact to market news, while prices recover only slowly b Violation of the EMH - An investor could earn abnormally high returns by buying a stock after bad news is announced, then reselling later. 4. Excessive Volatility b Fluctuations in stock prices tend to be greater than changes in intrinsic value b Smaller fluctuations when markets are closed. 6/29/2009 2 Evidence Contradicting Market Efficiency 5. Mean Reversion b Stocks that have done poorly in the recent past tend to do well in the future. b Newer data is less conclusive – remains controversial. 6. New Information and Stock Prices b Not immediately incorporated b Stock prices continue to rise after an unexpectedly high earnings announcement, etc. Implications of the EMH b Should you be skeptical of hot tips? Why? b If the stock market is efficient, it has already priced the hot tip stock so that its expected return will equal the equilibrium return. b Advice for the Practical Investor b Adopt a “Buy and Hold” Strategy b The “Econ 423” Stock Portfolio b Everyone pick a single stock, and email Lauren with your pick....
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This note was uploaded on 08/31/2009 for the course ECON 423 taught by Professor Vd during the Summer '08 term at UNC.

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