Class Note 9_S2010 - RSM 330 - I nvest ment s Por t folio M...

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RSM 330 - Investments Portfolio Management – August 5, 2010 Maureen Stapleton, CFA 1 RSM 330_Class 10_Summer 2010
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Plan for Today Portfolio Management Efficient M arket Hypothesis (EM H) An important assumption underlying CAPM and MPT Some Basic Issues Supportive Evidence for EMH Challenges against EM H Anomalies Multifactor Explanations More on your project 2 RSM 330_Class 10_Summer 2010
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Readings Bodie: Chapters 4,4; 10.1 -10.5; 12.3 ; 21.3- 21.5 - Multifactor Explanations – Fama & French Optional articles: “Does the Stock Market Over react?” Liquidity and the Post-Earnings Announcement Drift” New article to help you with Assignment 2 (Question 3) “The Style Roulette and RAFI © Strategy” 3 RSM 330_Class 10_Summer 2010
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Efficient Market Theory (EMH) ….…the basics EM H contends that market prices are correct. Market prices fully reflect all available information . – Expectations about future cash flows are correct. – The discount rate is correct. I f EM H is true, there is no “free lunch”. - The only way to earn higher average returns is by taking on more risk - No one can beat the market by stock picking or market timing. EM H is about the I nformational Efficiency of the market Prices react to new information quickly and to the right extent . 4 RSM 330_Class 10_Summer 2010
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Three forms of market efficiency: Weak form - information on past prices has been incorporated into current prices. Semi-strong form - all public information has been incorporated into current prices. Strong form - all public and all insider information has been incorporated into current prices. Basic Questions: Why would we expect market to be efficient? Arbitrage : Smart investors exploit the mispricing of securities until it disappears. Can markets be perfectly efficient? • If so, no one can beat the market & everyone would follow a passive strategy. • Then there would be no arbitrage to remove mispricing. H ow efficient are markets? Conclusion: Markets are somewhat efficient! 5 RSM 330_Class 10_Summer 2010
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2. How can we tell if markets are inefficient (ie not efficient) ? Look for stock-picking strategies that have earned higher returns with lower risk. Caveat …. it’s possible that we may not be measuring risk properly . – This is the “ Joint H ypothesis Problem .” 1. Does EM H imply that stock prices are random walks? Yes if risk is constant . I t is not true if risk changes over time .(ie if risk is time varying) – For example, D/P ratios may be correlated with risk and hence they can predict returns or changes in stock prices.
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This note was uploaded on 07/16/2011 for the course COMMERCE 330 taught by Professor Stapleton during the Fall '10 term at University of Toronto- Toronto.

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Class Note 9_S2010 - RSM 330 - I nvest ment s Por t folio M...

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