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Brailsford3eSM_Ch10 - Chapter 10 Market efficiency Learning...

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Copyright © 2006 Nelson Australia Pty Limited Chapter 10 Market efficiency Learning objectives After the completion of this chapter, you should be able to: understand the notion of an efficient capital market appreciate the different types of efficiency and how they apply to financial markets understand the role of information in setting security prices discuss the empirical evidence surrounding the concept of market efficiency understand the implications of empirical studies for practical investment analysis comprehend the debate surrounding market efficiency, particularly the controversy over the era of New Finance present a logical, referenced and reasoned argument as to whether or not markets are efficient. Key points 1 Most, if not all of the fundamental theories in finance rely upon some form of market efficiency. 2 Efficiency depends on how information set is defined. 3 Rather than being wholly efficient, the market displays both efficient and inefficient characteristics. Chapter outline 10.1 Introduction 1 Efficiency is one of the most debated concepts in finance. 2 In an efficient market, information is incorporated instantly in the share price, such that using this information cannot result in persistent excess returns. 10.2 Issues of efficiency 1 Efficiency is composed of informational efficiency and market rationality. 2 Fama (1991) proposed three-way definition whereby efficiency is tested in terms of predictability, event studies and private information. 3 Tests suffer from joint test problem, whereby to test market efficiency, need to assume a pricing model and vice versa. 10.3 Efficiency and past price information 1 Tests revolve around predictability of returns from past information. 2 Examples of tests include random walks, trends, and technical analysis. 3 Evidence of daily and monthly seasonality and intraday volatility.
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2 Investments: Concepts and Applications Solutions Manual Copyright © 2006 Nelson Australia Pty Limited 10.4 Efficiency and accounting information 1 Test responses to earnings announcements. Tests use event studies methodology. 2 Evidence of announcements to dividends, earnings as well as post-earnings drift. 10.5 Efficiency and economic information 1 Tests market price movements to economic information, such as money supply, GDP and interest rate announcements. 10.6 The pricing of firm size 1 Evidence that small firms outperform large firms. However, relationship is non-linear and is greatest for the smallest firms. Size effect appears to be closely related to January effect. 2 Questions adequacy of pricing models like the CAPM. 10.7 Growth shares versus value shares 1 Finding that a firm’s growth to value ratio is related to the firm’s returns. 2
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Brailsford3eSM_Ch10 - Chapter 10 Market efficiency Learning...

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