T7+2011 - Fina 3104 L2 T7 Market Efficiency Fixed-Income...

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Fina 3104 1 Fina 3104 L2 T7 § Market Efficiency § Fixed-Income Securities
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Fina 3104 2 Q1:(3mins) If markets are weak-form efficient, what should be the correlation coefficient between stock returns for two non- overlapping time periods, why?
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Fina 3104 3 Q1 solution The correlation coefficient between stock returns for two non-overlapping periods should be zero. If not, one could use returns from one period to predict returns in later periods and make abnormal profits.
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Fina 3104 4 Market Efficiency – Serial Correlation If the market is weak-form efficient, abnormal returns should have zero serial correlation. However, it is argued that US Stocks have shown momentum in the medium run and reversal in the long run. You want to examine whether HK Stocks also have momentum and reversal. Describe the steps how you would carry out your test (starting from data collection).
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Fina 3104 5 Solution 1. First, you need the historical prices of all HK stocks and the Hang Seng Index, as well as the riskfree rate (use US T-Bill as an approximation). You could get them from REUTERS. (Ideally you also need information on dividend payments. But this is more difficult to get.) 2. Calculate the returns on each stock and the Hang Seng Index. Depending on your test, you can calculate daily, weekly, or monthly returns.
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Fina 3104 6 Solution 3. You should calculate abnormal returns. You can assume a CAPM (or Single Factor Model), and use a period as the estimation period. Using the return data in the estimation
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T7+2011 - Fina 3104 L2 T7 Market Efficiency Fixed-Income...

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