ECON 3420 Discussion 4

ECON 3420 Discussion 4 - ECON 3420A Financial Economics...

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
ECON 3420A Financial Economics 2010-2011 Term 1 Discussion 4: Efficient Market Hypothesis (EMH) – Evidence (I) 1. Setting aside the technical elements of the volatility test, can you present in common sense terms why a market that is too volatile in the price level cannot be efficient. According the efficient market hypothesis, the current price has already reflected all the available information in the market. Thus, price movement is only driven by new additional information. If there is no new additional information, there should be no price movement. In addition, by the implication of EMH, when there is good news available in the market, the price should engage in a quantum jump and reach the equilibrium price immediately instead of fluctuating around. The incessant fluctuation of price level shows that this price movement may not be driven by information but by the overreaction of investors. Thus, a market that is too volatile in the price level cannot be efficient. Also, the stock price is equal to the discounted expected future dividends. As a corporate have unlimited life and the expected future dividends should not be affected much in long term by new information because the economy will recover one day; new information only affects the short-term expected future dividends. Thus, the stock price should be rather stable. This also explains a market that is too volatile in the price level cannot be efficient.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Alternative version: A market should not be efficient if the price level is too volatile. For not using the volatility test, we are trying to explain it in a rather “common sense” approach. Firstly, we can recognize that in the EMH model, any price movement is driven by the information available. If the market is efficient, the great fluctuation on price level would all because of the change in information. However, we highly doubt on whether is there “so much” information to cause the price volatility. Secondly, the price of a stock could be calculated by the discounted sum of the future dividends of that stock (resembles the NPV rule). Given that the life of a listed firm is infinite and great shocks like the financial tsunami would only affect the first few years’ dividend, the present price is not likely to be fluctuating greatly. Moreover, some discussants pointed out that the dividends over years are rather stable even facing great shocks. Concluding the above, the price takes no grounds to be such volatile if the market is really efficient.
Background image of page 2
Alternative version: At the very beginning, we should have a understanding of a efficient market. Under EMH, price movement depends on information changed. Information is well known by public. If information changes, people expectation will change without delay, and so the price will change to the expectation immediately. No one get gain in the market. Efficient means the market is always true in pricing. That means if information comes,
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 03/03/2012 for the course ECON 3420 taught by Professor Kwong during the Spring '11 term at CUHK.

Page1 / 11

ECON 3420 Discussion 4 - ECON 3420A Financial Economics...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online