Econ2035_Ch7

But it is hard to imagine such a huge change it may

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Unformatted text preview: rned abnormally high returns over long periods of 7me, even when the greater risk for these firms has been taken into account. But it seems to have diminished •  January effect Stock prices have tended to experience an abnormal price rise from December to January that is predictable and hence inconsistent with random ­walk behavior. Disappearing recently •  Market overreacMon Stock prices may overreact to news announcements and the pricing errors are corrected only slowly 21 Evidence Against Market Efficiency •  Excessive volaMlity Fluctua7ons in stock prices may be much greater than are warranted by fluctua7ons in their fundamental value, which ul7mately determine the equilibrium return •  Mean reversion Stocks with low returns today tend to have high returns in the future, and vice versa. This is predictable movements in stock price movements •  New informa7on is not always immediately incorporated into stock prices. 22 Prac7cal Guide to Stock Market Investment •  Recommenda7ons from investment advisors cannot help us outperform the market •  A hot 7p is probably informa7on already contained in the price of the stock •  Stock prices respond to announcements only when the informa7on is new and unexpected •  A “buy and hold” strategy is the most sensible strategy for the small investor 23 Stock Market Crash and Ra7onal Expecta7on •  The ra7onal expecta7on theory itself is not inconsistent with stock market crashes (1987, 2001, and 2008) •  A large change in stock prices can result from new informa7on that produces a drama7c change in the op7mal forecast. But it is hard to imagine such a huge change •  It may suggest that stock prices are also affected by non ­fundamental factors (e.g., market psychology, ins7tu7onal factors) •  As long as the crash is unpredictable, the basic lessons hold 24 Bubble •  Bubble: A situa7on where the price of an asset differs from its fundamental value. •  Examples: –  Dutch tulip bubble (“tulip mania,” 1637) –  Asset price bubble in Japan (the late 80’s and early 90’s) –  Housing bubble in US (2006) 25 Bubble •  Ra7onal bubble: –  Investors can have ra7onal expecta7ons that a bubble is occurring because the asset price is higher than its fundamental value but con7nue to hold the asset anyway –  Asset prices can therefore deviate from their fundamental value for a long 7me since the burs7ng of the bubble cannot be predicted 26 Behavioral Finance •  New approach to understand the behavior of securi7es prices, incorpora7ng concepts from other studies (psychology, anthropology, sociology, etc…) •  Prospect theory v...
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This note was uploaded on 06/11/2012 for the course ECON 2035 taught by Professor Stahl during the Spring '08 term at LSU.

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