11-Tests and evidence related to market efficiency

11-Tests and evidence related to market efficiency - Tests...

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Tests and evidence related to market efficiency Marriott School of Management Bus M 410 Winter 2011 Rob Schonlau Last updated Feb 21, 2011 1
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Lecture 11 Outline l Discuss the efficient market hypothesis and the random walk nature of price changes. l Discuss evidence of random and non-random price changes. You can view these results as tests of weak, semi-strong, and strong form EMH. Correlation in returns through time Relation between public information and future stock returns Relation between private information and future stock returns l Do portfolio managers and stock analysts add value? 2
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Efficient market hypothesis: Security prices are efficient in that they (already) reflect public information. Do security prices reflect information? Why is this an important question? Implications for business and corporate finance Implications for the value in active management, security analysis, and other investments 3
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Random walk and the EMH l Changes in stock prices are often described as a “random walk with drift”. In other words, stock price changes are random and not predictable. l Randomly evolving stock prices are the consequence of intelligent investors competing from moment-to-moment to discover relevant information. l Based on history, the expected change is positive but the day-to-day change varies randomly around the trend. 4
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Security Prices Time Random walk with positive trend 5
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Coin Flip Game versus the Value Weighted Returns of NYSE and ASE Stocks 50 100 150 200 250 Value 1 Value 2 Which of the above lines is from the coin flip? From the market? 6
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Why are price changes random? Prices react to (new) information The flow of (new) information is random Therefore, price changes are random Random price changes 7
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EMH and competition Why do prices react to news (new information)? l
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11-Tests and evidence related to market efficiency - Tests...

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