"411 02-2912_MarketEfficiency_handout

"411 - Lecture 6 Market Efficiency The Efficient Market Hypothesis Empirical Evidence BKM chapter 8 Readings Efficient Market Hypothesis

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
Lecture 6: Market Efficiency The Efficient Market Hypothesis Empirical Evidence Readings: BKM chapter 8
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
22 “Prices are (on average) right” Investors use all available information in forming expectations about future cash flows The discount rate reflects the riskiness of the stock à Prices immediately adjust to news à The only way to get higher returns is by taking on more risk + + + + = + + 2 2 1 ) 1 ( ) 1 ( r d r d E P t t t t Efficient Market Hypothesis
Background image of page 2
Efficient Market Hypothesis
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
44 Why? If securities were mispriced (e.g., one stock is overpriced and another stock is underpriced), smart investors could make unlimited profits by buying the cheap one and selling the expensive one. Efficient Market Hypothesis
Background image of page 4
55 “Prices are (on average) right” Investors use all available information in forming expectations about future cash flows The discount rate reflects the riskiness of the stock à Changes in stock prices represent a “fair returns” component (determined by the stock’s level of risk) plus some news/surprise component (which is unpredictable) + + + + = + + 2 2 1 ) 1 ( ) 1 ( r d r d E P t t t t Efficient Market Hypothesis - Evidence
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
66 In the short-run, “fair returns” are close to zero (e.g. if expected returns are 0.06 a year, expected returns are about 0.0002 a day (i.e., close to zero)). If investors condition on all available information, any change in daily stock prices must come from news about the company News, by definition, is unpredictable à Daily stock price movements are unpredictable à Stock prices follow a random walk, where the best estimate of tomorrow’s price is today’s price Efficient Market Hypothesis - Evidence
Background image of page 6
77 Can you tell apart a real stock price from a Random Walk? Guess which of the following 6 plots are random walks (created using the random number generator in Excel) and which are genuine stocks Data: daily returns from 1998 (252 trading days) Each “stock” has been “normalized” to have a starting value of $100 Efficient Market Hypothesis - Evidence
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
88 Can you tell apart a real stock price from a Random Walk?
Background image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 04/09/2011 for the course MGMT 411 taught by Professor Clarke during the Winter '09 term at Purdue University-West Lafayette.

Page1 / 24

"411 - Lecture 6 Market Efficiency The Efficient Market Hypothesis Empirical Evidence BKM chapter 8 Readings Efficient Market Hypothesis

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online