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Unformatted text preview: ION UNDER NONIDEAL CONDITIONS WITH UNCERTAINTY
(I.E. THE REAL WORLD)
¢༊ Single –Person Decision Theory Model
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༉ ༉ ¢༊ An individual who must make a decision under conditions of uncertainty
State probabilities are no longer objective and the individual sets out a formal
procedure whereby he can make the best decision by selecting from a set of
alternative choices
This procedure allows additional information to be obtained to revise the
decision maker’s subjective assessment of the probabilities of what might
happen after the decision is made An application of decision theory model in financial accounting
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༉ Investors have prior probabilities of future firm performance
Investors obtain useful information from financial statements and other sources
Investors revise their probabilities
Leads to buy/sell decisions
Security price changes
Return on share changes
Useful info. Prior
Prob. Revised
Prob. Buy/sell Price Return 15 EFFICIENT SECURITIES MARKETS
¢༊ Formed from a sufficient number of informed investors
¢༊ Definition (Semistrong form)
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༉ At all times…
Fully reflect...
All publicly available information…
A relative concept
¢༊ Efficiency defined relative to a stock of publicly available information ¢༊ Rational investors impound new information instantaneously.
¢༊ Implies a “fair game” – time series of prices is a random walk.
¢༊ The fundamental value of a firm’s share
༉ The value of a firm’s share on an efficient market if all information
about the firm is publicly available (i.e., no inside information) SHARE PRICE IN AN EFFICIENT MARKET
¢༊ SharpLintner ex ante CAPM suggests that risk free return, market return and equity
beta determine expected returns of a firm at a point in time. For example, at the end of
period t1, the expectation of returns to be realized at the end of period t is: E ( R j ,t ) = rf ,t + β j ( E ( RM ,t ) − rf ,t )
¢༊ Another way to look at expected returns is to examine expectations of next period
prices and dividends. For example, at the end of period t1, the expectation of returns to
be realized at the end of period t is E ( Pj ,t + D j ,t )
E ( R j ,t ) =
−1
Pj ,t −1 ¢༊ If the assumption is that expected returns (E(Rj,t)) do not change (i.e. the risk free rate,
expected market returns and equity beta do not change), then prices at the end of period
t1 (or beginning of period t) will have to change when there are changes in the
expectations of prices and dividends for end of period t.
Pj,t 1 = ¢༊ E(Pj,t + D j,t )
( 1 + E(R jt ) ) Accounting and other information drive share prices by allowing prediction of future
price and dividends. Predicting future prices and dividends requires prediction of future
cash flows to the firms.
17 HOW DOES ACCOUNTING INFORMATION AFFECT SHARE PRICE? Pj,t 1 = E(Pj,t + D j,t )
( 1 +...
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 Fall '13
 JianMing

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