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

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

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...
View Full Document

This note was uploaded on 06/11/2012 for the course ECON 2035 taught by Professor Stahl during the Spring '08 term at LSU.

Ask a homework question - tutors are online