Lecture14_winter09

Lecture14_winter09 - MARKET EFFICIENCY DEFINITION A Market...

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MARKET EFFICIENCY
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DEFINITION A Market is said to be Efficient if it sully reflects all information. Efficiency is not an absolute concept Depending on what type of information it fully reflects, there will be different levels of Market Efficiency
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In a Market that is Efficient with respect to some type of information, you can’t CONSISTENTLY make ECONOMIC PROFITS on the basis of that same type of information. At any point in time, the prices are a good estimate of their intrinsic value.
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ARBITRAGE The process by which the prices will adjust naturally to their intrinsic value This happens when the price does not reflect information adequately Traders, with knowledge of that information, will trade in a way that prices will move into their “true” values.
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RANDOM WALK If the Market is said to Efficient, the Prices and Returns follow a Random Walk. A Random Walk is a statistical process in which successive changes are statistically independent of each other and are unknown
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RANDOM WALK The process is said to be Random Walk if The important feature of the Random Walk is that E(e t+1 )=0. This means that the changes to the prices or returns of an Asset are completely unpredictable. 1 1 t t t e R R
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RANDOM WALK This means that given the information you have available, your best expectation of the price next period is the current price. E(R t+1 )=R t If you knew where the price was going to move to, you would CONSISTENTLY make ECONOMIC PROFITS by using that information.
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IS IT IMPORTANT? It determines your Investment Strategies:
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This note was uploaded on 01/28/2012 for the course ECON 134a taught by Professor Lim during the Winter '08 term at UCSB.

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Lecture14_winter09 - MARKET EFFICIENCY DEFINITION A Market...

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