chap008

chap008 - Chapter 08 The Efficient Market Hypothesis...

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Chapter 08 - The Efficient Market Hypothesis Chapter 8 The Efficient Market Hypothesis 1. The correlation coefficient should be zero. If it were not zero, then one could use returns from one period to predict returns in later periods and therefore earn abnormal profits. 2. c This is a predictable pattern in returns, which should not occur if the stock market is weakly efficient. 3. c This is a classic filter rule, which would appear to contradict the weak form of the efficient market hypothesis. 4. b This is the definition of an efficient market. 5. c The P/E ratio is public information so this observation would provide evidence against the semi-strong form of the efficient market theory. 6. b Public information constitutes semi-string efficiency, while the addition of private information leads to strong form efficiency. 7. a The information should be absorbed instantly. 8. b Since information is immediately included in stock prices, there is no benefit to buying stock after an announcement. 9. c Stocks producing abnormal excess returns will increase in price to eliminate the positive alpha. 8-1
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Chapter 08 - The Efficient Market Hypothesis 10. c A random walk reflects no other information and is thus random. 11. d Unexpected results are by definition an anomaly. 12. Assumptions supporting passive management are: a. informational efficiency b. primacy of diversification motives Active management is supported by the opposite assumptions, in particular, that pockets of market inefficiency exist. 13. a. The grandson is recommending taking advantage of (i) the small firm anomaly and (ii) the January anomaly. In fact, this seems to be one anomaly: the small-firm-in- January anomaly. b. (i) Concentration of one’s portfolio in stocks having very similar attributes may expose the portfolio to more risk than is desirable. The strategy limits the potential for diversification. (ii) Even if the study results are correct as described, each such study covers a specific time period. There is no assurance that future time periods would yield similar results. (iii) After the results of the studies became publicly known, investment decisions might nullify these relationships. If these firms in fact offered investment bargains, their prices may be bid up to reflect the now-known opportunity. 14. No, this is not a violation of the EMH. Microsoft’s continuing large profits do not imply that stock market investors who purchased Microsoft shares after its success already was evident would have earned a high return on their investments. 8-2
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Chapter 08 - The Efficient Market Hypothesis 15. No, this is not a violation of the EMH. This empirical tendency does not provide investors with a tool that will enable them to earn abnormal returns; in other words, it does not suggest that investors are failing to use all available information. An investor could not use this phenomenon to choose undervalued stocks today. The phenomenon instead reflects the fact that dividends occur as a response to good performance. After
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This note was uploaded on 02/25/2011 for the course FIN 3826 taught by Professor Staff during the Fall '08 term at LSU.

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chap008 - Chapter 08 The Efficient Market Hypothesis...

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