Chapter 13. Market efficiency

Chapter 13. Market efficiency - Market Efficiency Chapter...

Info iconThis preview shows pages 1–8. Sign up to view the full content.

View Full Document Right Arrow Icon
Market Efficiency Chapter 13 Finance 357
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Efficient Market Hypothesis The Efficient Market Hypothesis states that in an efficient market, stock prices fully reflect available information. This has several important implications Because information is reflected in prices immediately, investors should only expect to obtain a normal rate of return. Awareness of information when it is released does no good for an investor. Firms should expect to receive fair value for securities that they sell. Fair means that the price they receive for the securities they issue is the present value of all future cash flows.
Background image of page 2
Price Adjustment
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Conditions Leading Efficiency - 1 1. Rationality – All investors act in a rational way. For example, when a company announces that a new project is being undertaken and implies that it increase NPV by $5 per share, the stock price will rise by $5 immediately to reflect this information. This is because rational investors would see no reason to wait before trading at this new price.
Background image of page 4
Conditions Leading Efficiency - 2 1. Independent Deviations from Rationality If some investors reacted to the company announcement with skepticism, others in the market would react with over optimism and the group would cancel each other out and the stock would move in a rational way.
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Conditions Leading Efficiency - 3 1. Arbitrage – In a world where amateur investors risk small sums of money on emotional purchases of stock, they cancel themselves out. Professional investors rationally study stocks and identify when they are mispriced. These professional risk large sums of money and use arbitrage to instantly bring prices back to their rational value. Arbitrage is the simultaneous purchase and sale of different, but substitute, securities.
Background image of page 6
Weak Form Efficiency states that the markets fully incorporate past stock price information into current market prices. This means that a strategies such as one that recommends buying a stock after it has gone up three days in a row and then recommends selling a stock after it has gone down three days in a row will not produce a positive return. If such a strategy were useful, everyone could
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 8
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/09/2010 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas at Austin.

Page1 / 31

Chapter 13. Market efficiency - Market Efficiency Chapter...

This preview shows document pages 1 - 8. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online