Class Note 9_F2011 - RSM 330 - Investments Portfolio...

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1 RSM 330 - Investments Portfolio Management - Anomalies Performance Measurement November 17, 2011 Maureen Stapleton, CFA RSM 330_Class 9_Fall 2011
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2 Plan for Today Efficient Market Hypothesis (EMH) An important assumption underlying CAPM and MPT Challenges against EMH Anomalies Multifactor Explanations Measuring fund performance Tutorial today at 6pm …RW110 with Tyler RSM 330_Class 9_Fall 2011
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3 Bodie: Chapters 9.1-9.5, 11.3, 20.3-20.5 (6 th edition: 4.4; 10.1 -10.5; 12.3 ; 21.3- 21.6) Assignment 3 due November 24 at 4 pm in Rotman Commerce RSM 330_Class 9_Fall 2011
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4 Efficient Market Theory (EMH) ….…the basics EMH contends that market prices are correct. Market prices fully reflect all available information . – Expectations about future cash flows are correct. – The discount rate is correct. If EMH is true, there is no “free lunch”. - The only way to earn higher average returns is by taking on more risk - No one can beat the market by stock picking or market timing. EMH is about the Informational Efficiency of the market Prices react to new information quickly and to the right extent . RSM 330_Class 9_Fall 2011
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5 Three forms of market efficiency: Weak form - information on past prices has been incorporated into current prices. Semi-strong form - all public information has been incorporated into current prices. Strong form - all public and all insider information has been incorporated into current prices. Basic Questions: Why would we expect market to be efficient? Arbitrage : Smart investors exploit the mispricing of securities until it disappears. Can markets be perfectly efficient? • If so, no one can beat the market & everyone would follow a passive strategy. • Then there would be no arbitrage to remove mispricing. How efficient are markets? Conclusion: Markets are somewhat efficient! RSM 330_Class 9_Fall 2011
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6 2. How can we tell if markets are inefficient (ie not efficient) ? Look for stock-picking strategies that have earned higher returns with lower risk. Caveat …. it’s possible that we may not be measuring risk properly . – This is the “ Joint Hypothesis Problem .” 1. Does EMH imply that stock prices are random walks? Yes if risk is constant . It is not true if risk changes over time .(ie if risk is time varying) – For example, D/P ratios may be correlated with risk and hence they can predict returns or changes in stock prices. – This is the risk story for the D/P regression, which is consistent with EMH. RSM 330_Class 9_Fall 2011
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7 Supportive Evidence for EMH New information appears to be quickly incorporated into stock prices. Methodology:
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This note was uploaded on 12/20/2011 for the course RSM 330 taught by Professor Stapleton during the Fall '11 term at University of Toronto- Toronto.

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Class Note 9_F2011 - RSM 330 - Investments Portfolio...

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