3531Week6W11 - Week 6 Stock Price Behaviour and Market...

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1 Week 6 Stock Price Behaviour and Market Efficiency
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McGraw-Hill Ryerson Limited 2 Market Efficiency • The Efficient market hypothesis (EMH) is a theory that asserts: the major financial markets reflect all relevant information at a given time. Market efficiency research examines the relationship between stock prices and available information. – The important research question : is it possible for investors to ―beat the market?‖ – Prediction of the EMH theory: if a market is efficient, it is not possible to ―beat the market‖.
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McGraw-Hill Ryerson Limited 3 What Does ―Beat the Market‖ Mean? • The excess return on an investment is the return in excess of that earned by other investments that have the same risk. “Beating the market” means consistently earning a positive excess return .
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McGraw-Hill Ryerson Limited 4 Three Economic Forces that Can Lead to Market Efficiency • Investors use their information in a rational manner. Rational investors do not systematically overvalue or undervalue financial assets. If every investor always makes perfectly rational investment decisions, it would be very difficult to earn an excess return. • There are independent deviations from rationality. Suppose that many investors are irrational. The net effect might be that these investors cancel each other out. Irrationality is just noise that is diversified away. What is important here is that irrational investors have different beliefs.
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McGraw-Hill Ryerson Limited 5 Three Economic Forces that Can Lead to Market Efficiency • Arbitrageurs exist. Suppose collective irrationality does not balance out. Suppose there are some well-capitalized, intelligent, and rational investors. If rational traders dominate irrational traders, the market will still be efficient. These conditions are so powerful that any one of them leads to efficiency.
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6 Forms of Market Efficiency, A Weak-form Efficient Market is one in which past prices and volume figures are of no use in beating the market. A Semistrong-form Efficient Market is one in which publicly available information is of no use in beating the market. A Strong-form Efficient Market is one in which information of any kind, public or private, is of no use in beating the market.
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7 Information Sets for Market Efficiency
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8 Does Old Information Help Predict Future Stock Prices? • Researchers have used sophisticated techniques to test whether past stock price movements help predict future stock price movements. -- Some researchers have been able to show that future returns are partly predictable by past returns. But there is not enough predictability to earn an excess return. – Trading costs swamp attempts to build a profitable trading
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This note was uploaded on 05/01/2011 for the course ADMS 3531 taught by Professor Profp during the Winter '10 term at York University.

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3531Week6W11 - Week 6 Stock Price Behaviour and Market...

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