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Thus asset c will be at equilibrium only when the 2

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Unformatted text preview: ed during short intervals are unpredictable. Despite the finding of significant serial correlations in some, the relationship is not economically significant, because it cannot be used to formulate a trading strategy that is profitable once transaction costs are taken into account. Similar to the technical analysis, the finding of a predictable pattern in stock returns would violate all 3 forms of market efficiency, whereas the finding of unpredictable stock price movements can only be used to support weak form market efficiency. However, Fama and French (1988) found contradicting to weak form efficiency, as they observed negative serial correlation measured over long intervals (successive 5 year returns) for 10 year equally weighted portfolio of stocks that were grouped by size. The effect is more pronounced for more stocks. Despite this anomaly that stock movement prices are predictable, this may be entirely due to the varying nature of risk aversion, and hence risk premiums. As the market participants become more risk averse and demand a larger market price of risk, larger risk premiums on stocks will result. If the change in market sentiment occurs frequently at regular intervals of 5 years, then the negative serial correlation can be due to the observations of a 5 year optimistic period, followed by a 5 year pessimistic period. Another test of random price movements is to test for differences in returns on different days of the week. Although French (1980) observed differing returns on different average returns of different days of the week, this day-of-the-week effect is not economically significant. This is because, the associated trading rule of buying near the close of trade on Monday and selling near the close of trade on Friday is not profitable after taking into account transaction costs. 5 Cheryl Mew FINS2624 – Portfolio Management Semester 1, 2011 T ESTING THE MARKET FOR SEMI-STRONG FORM EFFICIENCY F UNDAMENTAL ANALYSIS Fundamental analysis tests the performance of stocks, by using pu...
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