NHO Chap 8-9 - 8.3 Are Markets Efficient? 8-1 Recall that...

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Unformatted text preview: 8.3 Are Markets Efficient? 8-1 Recall that over time stock prices tend to follow a ____________________ This has nothing to do with efficiency, per se. It does however have serious implications for ________________. In words this says that a _________________ ______________________________________ _____________. Empirical Tests of Informational Efficiency submartingale process tests of efficiency randomly chosen portfolio of stocks can be expected to have a positive return 8-2 In practice this means that when trying to figure out if some portfolio manager is earning abnormal returns we must ____________________________ _______________________. I.E. they must ____________________________, or in practice they must beat ____________________ ________. Empirical Tests of Informational Efficiency compare their performance to a randomly chosen portfolio outperform the random portfolio some benchmark rate of return 8-3 a. b. Empirical Tests of Informational Efficiency Can anyone consistently earn an abnormal return? This says that investors do not repeat the same mistakes over and over in an irrational fashion. For example, sometimes they may overestimate the impact on earnings of some event and sometimes they underestimate the impact on earnings but on average the estimates are unbiased . Do investors systematically misinterpret information? 8-4 Event studies Assessing performance of professional managers Testing a trading rule Empirical Tests of Inform. Efficiency Examine how quickly information is integrated into prices around an informational event. EMH suggests rapid assimilation of information into prices. Can professional managers, using their resources and tools, beat the market after considering risk? EMH suggests professionals will not outperform the market. Testing whether a rule that uses available information can earn abnormal returns after considering the risk and cost of using the rule. EMH suggests that such rules will not work. 8-5 1. Examine prices and returns around some material announcement How Tests Are Structured 8-6 +t +t-t-t Announcement Date Announcement Date = abnormal return Individual Abnormal Returns Surrounding the Event in an _______________ Efficient Market Earnings above forecast for example Earnings above forecast for example 8-7 +t +t-t-t Announcement Date Announcement Date Earnings above forecast for example Earnings above forecast for example = abnormal return Inefficient Market Individual Abnormal Returns Surrounding the Event in an _______________ 8-8 1. How do we determine if the returns are abnormal? Market Model approach a. b. How Tests Are Structured (cont.) r t = a + b(r index,t ) + e t Estimate a and b coefficients Abnormal Return or AR = (Actual - Expected ) AR t = e t = Actual return [a + b(r index,t )] 8-9 2. continued: c. Cumulate the abnormal returns over time: +t +t-t-t How Tests Are Structured (cont.) In this case there appears to be information leakage before the announcement date (day 0), but markets adjust quickly to new information....
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This note was uploaded on 11/23/2010 for the course FINANCE 08FB40447 taught by Professor Raymond during the Spring '10 term at University of Manchester.

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NHO Chap 8-9 - 8.3 Are Markets Efficient? 8-1 Recall that...

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