week 10 - Week 10 Tutorial Emily Lo Efficient Market...

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Week 10 Tutorial Emily Lo
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Efficient Market Hypothesis A financial market is said to be efficient if asset prices respond to relevant information instantaneously and accurately This implies: - no one is able to make abnormal returns as prices reflect all information available - stock price movements are unpredictable follow a random walk
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Three forms of Market Efficiency Each versions differ by their notions of what is meant by the term “all available information” 1. Weak Form - stock prices already reflect all information that can be derived by past trading data - implies trend analysis is worthless 2. Semi Strong Form - all publicly available information regarding the prospects of a firm must be reflected in stock price - in addition to past trading data, includes information regarding the industry, economy and the firm - implies fundamental analysis is worthless 3. Strong form - stock prices reflect all information relevant to the firm, even including private information known to corporate insiders - implies active portfolio management is worthless
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Testing the Weak form Evidence that supports the weak form: Trading rules that result from technical analysis is not profitable (Ball, 1978) No serial correlation between daily returns over short intervals This supports that stock prices do not have predictable patterns Anomalies: Negative serial correlation observed over long intervals (Fama Portfolios containing the worst stocks in the past 5 years outperform portfolios containing the best stocks in the past 5 years consistently over the next 5 years (Choper et al, 1992)
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Testing the semi-strong form Evidence that supports the semi-strong form (Jones et al, 1984): Pre-announcement drift - this reflects information leakage and prices are responding to it
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This note was uploaded on 01/10/2012 for the course FINS 3616 taught by Professor Curry during the Three '10 term at University of New South Wales.

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week 10 - Week 10 Tutorial Emily Lo Efficient Market...

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