Lecture_10

Lecture_10 - Market Efficiency Professor Ruslan Goyenko...

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Professor Ruslan Goyenko Market Efficiency Fall 2010 Investment Management, FINE 1
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Fall 2010 Investment Management, FINE 2 The Efficient Market Hypothesis (EMH) Ø Market efficiency means: - prices are correct: they fully reflect all available information - people use all available information in forming expectations about future cash flows - the discount rate is right for the riskiness of the cash flows - prices react to new information quickly and to the right extent - there is no free lunch: * the only way you can get higher returns is by taking on more risk * there is no information out there that can be used to construct strategies that earn returns higher than required for their risk * when we say ‘prices are correct,’ we are implicitly stating what ‘correct’ is (i.e., we are implicitly assuming an asset-pricing model).
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Fall 2010 Investment Management, FINE 3 What information are we talking about? Ø Information contained in past prices Ø Public information Ø Private information We can characterize markets as: weak semi-strong strong -form efficient is all: past price public private information is already incorporated into prices.
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Fall 2010 Investment Management, FINE 4 Weak Form Efficiency Ø Current prices fully reflect all information in past prices. ‘technical’ analysis using past price patterns will not produce profits - Are deviations within transactions and trading costs? - Fairly convinced that markets are weak form efficient. - But new evidence (e.g. momentum strategies) has challenged this.
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Fall 2010 Investment Management, FINE 5 Is the market weak form efficient? Evidence: For the market portfolio is approximately zero Random Walk For stocks/portfolios tends to be: Negative at short horizon (up to one month) Positive at intermediate horizon (up to one year) Negative at long horizon (5 years) Testing whether the market processes information in past prices: t i t i i t i r r , 1 , , ε γ α + + = - Weak Form Efficiency – Cont’d
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Self-destruction of Trading Rules Fall 2010 Investment Management, FINE 6 Stock Price Last week This week Next week Upswing Price as soon as upswing is recognized
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This note was uploaded on 02/28/2012 for the course FINE 441 taught by Professor Ruslangoyenko during the Spring '08 term at McGill.

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Lecture_10 - Market Efficiency Professor Ruslan Goyenko...

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