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week_05_Market_Efficiency - Markets and Information Market...

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Markets and Information Market Efficiency
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Week 5 FINS5513 2 Overview So far we have considered a number of asset pricing models These have all required that price is a good reflection of value Is this likely to be the case? How? Why?
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Week 5 FINS5513 3 Today Trend and predictability Efficient market hypothesis Implications Supporting evidence Barriers to the EMH Behavioural biases Anomalies Can we build a fully efficient market?
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Week 5 FINS5513 4 Market Efficiency Efficiency in engineering: the best possible use of the inputs. An efficient market: investors make the best possible use of information. A useful initial perspective: As speculators we are trying to predict where a stock price will be in the future. Do we know anything today that will help us make this prediction?
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Week 5 FINS5513 5 Price of GE 88 90 92 94 96 98 100 102 104 0 20 40 60 80 100
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Week 5 FINS5513 6 Are Prices Predictable? There are apparently short-run trends If we know we are at the start of a downward trend, sell short If we know we are at the start of an upward trend, buy How do you know when a trend is starting? ending? Can we devise rules (statistical or “technical”)?
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Week 5 FINS5513 7 Trend and Predictability The price path is simulated: Price(Today) = Price(Yesterday) + x, where x is a standard normal random variable This process is called a random-walk By construction, any trends that appear in a particular sample price path arise purely from chance There are no rules that will help us identify trends in time for us to profit by them Do trends imply predictability?
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Week 5 FINS5513 8 Efficient Market Hypothesis (EMH) Stock prices reflect all available information: Weak-form efficiency Price fully reflects all information contained in trading history (price, volume, etc) Semi-strong-form efficiency Price fully reflects all public information on the firm (accounting information, etc.) Strong-form efficiency Price reflects all public and private information known to investors
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Week 5 FINS5513 9 What makes a market efficient?
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