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321Class12-EMH%20%26%20Risk - Efficient Market Hypothesis...

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Efficient Market Hypothesis
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Rational Decision Making Randomness Efficient Markets Academic issues vs. real decisions Puzzles & Anomalies Investor behavior Market behavior Corporate behavior
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Lessons of Market Efficiency 1. Markets have no memory 2. Trust market prices 3. Read the entrails 4. There are no financial illusions 5. The do-it-yourself alternatives 6. Seen one stock, seen them all
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Risk v. Return
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Defining Risk Insurance definition: Probability of an event * value of the event Frequency * Severity Financial definition: Deviation from the expected return Deviation from the mean
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Risk = Unpredictable Outcome Pure Risk Loss No Loss Speculative Risk Loss No Loss GAIN Risk = Variation from expected outcome
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Risk Management Process
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Named Risks Business risk Strategic risk Operational risk Legal/Regulatory risk Physical risk Systemic risk Modeling risk Auditor risk model, estimation risk, projection risk
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Strategic Risk Examples Competition Regulation Technological innovation Political impediments Modeling errors
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Operational Risk Causes of operational risk Internal processes People Systems Examples Product recall Customer satisfaction Information technology Labor dispute Management fraud
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Hazard Risk “Pure” loss situations Property Liability Employee related Independence of separate risks Risks can generally be handled by Insurance, including self insurance Avoidance Transfer
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Financial Risks Financial Risk Market risk Transactional risk Interest rate risk Liquidity risk Credit risk Bankruptcy
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Market Risks Unique Risk Stand-alone Risk Market Risk Systematic Risk Systemic Risk
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Risk Measurements Exposure Volatility Probability Severity Time horizon Correlation Capital
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