Ch8_Kim_BKM_INV_7th - Bodie Kane Marcus Essentials of...

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Essentials of Investments Bodie • Kane • Marcus Chapter 8 The Efficient Market Hypothesis
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Essentials of Investments Bodie • Kane • Marcus Efficient Market Hypothesis (EMH) EMH: Prices of securities fully and immediately reflect all available information about securities. A forecast about favorable future performance leads instead to favorable current performance, as market participants all try to get in on the action before the price jump. Stock price should follow Random Walk. Price changes are random and unpredictable. Prices change only in response to new information, which should not be predictable; The stock prices that change in response to new information also must move randomly. If prices were predictable, that would be the evidence of stock market inefficiency.
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Essentials of Investments Bodie • Kane • Marcus Efficient Market Hypothesis (EMH) Any investment strategy cannot make abnormal returns consistently. If there is an investment strategy which can exploit the mispricing, consistent abnormal returns cannot be earned because mispricing will be disappeared. Why should we expect stock prices to reflect all available information? Many investors will try to analyze and uncover new information before any other investors do, in order to improve investment performance. Competition among these many analysts ensures that stock prices ought to reflect available information regarding their proper levels.
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Essentials of Investments Bodie • Kane • Marcus Three Versions of the EMH According to the notion of what is meant by the term, “All available information.” Weak-form EMH Stock prices already reflect all information contained in the record of past prices . Trend analysis is meaningless. Semistrong-form EMH Stock prices already reflect not only past prices but also all publicly available information . With semistrong-form efficiency, no consistent abnormal return over a normal return predicted by SML, but an occasional abnormal return only by luck or publicly unavailable information.
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Essentials of Investments Bodie • Kane • Marcus Three Versions of the EMH Semistrong-form EMH (continued) Whenever information is released to public, stock prices will respond only if the information is different from what had been expected. Strong-form EMH Stock prices already reflect all the information , even including information available only to company insiders. Quite extreme version of EMH. If the market is efficient in strong-form, there would be lucky or unlucky investors, but there would not be any superior investment managers who can consistently beat the market.
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Essentials of Investments Bodie • Kane • Marcus Implications of EMH: Investment Policy Technical Analysis Research on predictable patterns in stock prices, using prices and volume data, to predict future prices. Weak-form efficiency: Technical analysis is without merit.
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This note was uploaded on 12/13/2011 for the course MANAGEMENT 103 taught by Professor Mr.singh during the Spring '11 term at Aristotle University of Thessaloniki.

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Ch8_Kim_BKM_INV_7th - Bodie Kane Marcus Essentials of...

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