Chapter 4_Notes

Chapter 4_Notes - Chapter 4 Notes The Meaning of Efficiency...

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Chapter 4 Notes The Meaning of Efficiency A certain number of investors will spend considerable time/effort/money to acquire and use information to guide investment decisions. Such expert investors are called informed. They move quickly to gather information and when a large enough number of people behave in this way the market moves closer and closer to becoming fully efficient. The definition of efficiency implies that once new or corrected information becomes publicly available, the marketplace will quickly adjust to it because rational investors scramble to revise their beliefs about future performance as soon as new info becomes known. The result of this is that the expected returns and risk they associate with existing payoffs will change and they will participate in the market to restore their optimal risk/return trade-offs. Market Efficiency: refers to the speed with which securities in the capital markets respond to the new information. Efficient Securities Market (semi-strong form): a market where prices of securities traded as per that market always fully reflect all information that is publicly known. This theory and efficiency of the market does not eliminate the possibility of ‘inside’ information. Market efficiency is a relative concept. The market is efficient relative to a stock of publicly available information. The definition does not suggest that market prices always reflect the real underlying value of a firm. The implication of a fair game also exists and works to manipulate investor expectations such that they cannot expect to earn excess returns over and above normal expected returns. Examining the time series formed by the sequence and security price changes for a particular security, the series should fluctuate randomly over time according to market efficiency theory, with a time series that exhibits such serially uncorrelated behavior designated as the random walk theory. Price fluctuations occur because some pieces of relevant but unexpected information are unearthed and need to be factored into the price How Do Market Prices Fully Reflect All Available Information? Market efficiency does not guarantee that security prices fully reflect firm value (due to the existence of ‘inside information’ and/or incorrect information), but does suggest that prices are unbiased relative to publicly available info and will quickly reflect and react to new and/or relevant information.
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Chapter 4 Notes In the absence of further news, should prices continue to rise in the following days, this provides evidence for an inefficient market. It is very likely that different investors will react differently given the same info even if they all proceed rationally. One can think of these instances of acting differently from one investor to the next as
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This note was uploaded on 12/14/2010 for the course ACC 706 taught by Professor Shadifarshad during the Winter '09 term at Ryerson.

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Chapter 4_Notes - Chapter 4 Notes The Meaning of Efficiency...

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