chapter10 - Chapter 10: CHAPTER OVERVIEW Market Efficiency...

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Chapter 10: Market Efficiency CHAPTER OVERVIEW A chapter on market efficiency is a natural sequence to a chapter dealing with Capital Market theory and how financial assets are priced in the marketplace. It is also desirable for students to be familiar with this topic relatively early in the course so that market efficiency can be referred to when discussing other topics, such as technical analysis or fundamental security analysis. Chapter 10 begins by explaining the rationale for arguing that the market is efficient. It then proceeds to outline the classic three forms of market efficiency laid out by Fama in 1970: weak, semi-strong, and strong. Evidence on market efficiency is presented in some detail, starting with weak form efficiency and concluding with strong form efficiency. Within the weak form section the distinction is made between statistical tests and trading rule tests. In the semi- strong form section the concept of event studies is developed, along with abnormal returns. Strong form evidence is developed in considerable detail. Chapter 10 presents a thorough analysis of the implications of the EMH. This is important in getting students to think about the real issues involved here. The implications for both technical analysis and fundamental analysis are considered, along with those for money managers. This discussion serves as a good introduction to the last part of the chapter on possible market anomalies. Chapter 10 concludes with a complete discussion of possible market anomalies or evidence of possible market inefficiency. This evidence is divided into earnings announcements (which is related to the unexpected earnings concept in Chapter 17), low P/E ratios, the size effect, the January effect, and the Value Line results. The chapter ends with some conclusions about market efficiency. It is important for students to think about what they have learned and the implications for their approach to investing in general and to such areas as technical analysis in particular. The reference to the Keane article ( Financial Analysts Journal , March-April 1986) is important. This is a very desirable article to read with regard to efficient markets. 10-1
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Overall, most instructors will want to leave their students with a balanced view of the efficient market controversy. Certainly, the evidence on market efficiency cannot be ignored. It is too well documented, and augmented by such factors as the mediocre performance of professional fund managers. On the other hand, to date no one has conclusively explained why the anomalies exist. There may in fact be explanations, but they have not been widely accepted. Much work in this area remains to be done. Students must realize that in the area of efficient markets, as in
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chapter10 - Chapter 10: CHAPTER OVERVIEW Market Efficiency...

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