cacc 706_ch 04

cacc 706_ch 04 - OVERVIEW: Interaction of rational...

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OVERVIEW: Interaction of rational investors in a securities market Security prices “fully reflect” the collective knowledge and information-processing expertise of investors Securities market efficiency has important implications for financial accounting One implication is that IT LEADS DIRECTLY TO THE CONCEPT OF FULL DISCLOSURE Efficiency implies that: it is the INFORMATION CONTENT OF DISCLOSURE , not the form of disclosure , that is valued by the market Accounting will survive only if it is relevant, reliable, timely, and cost effective, relative to other sources 4.2 EFFICIENT SECURITIES MARKETS 4.2.1 T HE M EANING OF E FFICIENCY In Chapter 3 we studied the optimal investment decisions of rational investors. Now consider what happens when a large number of rational individuals interact in a securities market, that is: 1. The characteristics of the market prices of securities traded in the market 2. How these prices are affected by new information. Investors want to know which state of nature was realized, since this affects the future share price and dividends of the firm Under Ideal Conditions (Ex 2.2) By assumption, information is free since state realization is publicly observable Thus, all investors would use this information, and the process of arbitrage ensures that the market value of the firm then adjusts to reflect the revised cash flow expectations that result Unfortunately, information is not free under non-ideal conditions Investors have to decide how much accounting expertise and information to acquire, and then to form their own subjective estimates of firms’ future performance These estimates will need revision as new information comes along Each investor then faces a cost–benefit trade-off w/ respect to how much information to gather Informed investors are those investors that spent considerable time and money to gather information sources to guide their investment decision
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An efficient securities market is one where the prices of securities traded on that market at all times fully reflect all information that is publicly known about those securities This is achieve when a sufficient number of informed investors respond quickly to new information received 3 points are particularly noteworthy: 1. Market prices are efficient with respect to publicly known information The definition does not rule out the possibility of inside information Persons who possess inside information, in effect, know more than the market If they wish to take advantage of their inside information, insiders may be able to earn excess profits on their investments at the expense of outsiders That is: The market prices of these investments reflect only outside or publicly available information 2. Market efficiency is a relative concept The market is efficient RELATIVE TO a stock of publicly available information. There is nothing in the definition to suggest that the market is omniscient and that
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This note was uploaded on 03/27/2012 for the course ACC 706 taught by Professor Shadifarshad during the Spring '09 term at Ryerson.

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cacc 706_ch 04 - OVERVIEW: Interaction of rational...

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