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Slide8 - Chapter8 8. MarketHypothesis (EMH EMH suggest...

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Chapter 8 The Efficient Market Hypothesis
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8.1 Random Walks and The Efficient Market Hypothesis
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Efficient Market Hypothesis (EMH) The hypothesis that prices of securiAes fully reflect available informaAon about securiAes. EMH suggest stock prices should not be predictable.
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CumulaAve abnormal returns before and aEer the announcement of a takeover aFempt
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Stock price reacAon to on‐air reports during the “Midday Call” on CNBC
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EMH and CompeAAon CompeAAon among investors implies that stock prices fully and accurately reflect publicly available informaAon very quickly. Else there are unexploited profit opportuniAes. Once informaAon becomes available, market parAcipants quickly analyze it & trade on it & frequent, low cost trading assures prices reflect informaAon. QuesAons arise about efficiency due to: • Unequal access to informaAon • Structural market problems • Psychology of investors (Behavioralism )
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Random Price Changes In very compeAAve markets prices should react to only NEW informaAon Flow of NEW informaAon is random Therefore, price changes are random Idea that stock prices follow a “Random Walk”
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Random Walk and the EMH Random Walk: stock price changes are random and unpredictable . Stock prices actually follow a Random Walk with a posiAve trend. Investors expect stocks to have a positive risk premium
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Random Walk with PosiAve Trend Security Prices Time
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Forms of the EMH Prices reflect all relevant informaAon Varying InformaAon Set : Weak, semi‐strong, strong form of EMH Weak form EMH
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