(38) Market Efficiency Flashcards
LOS 47. a: Describe market efficiency and related concepts, including their importance to investment practitioners.
Describe an informationally efficient market
In an informationally efficient capital market, security prices reflect all available information fully, quickly, and rationally. The more efficient a market is, the quicker its reaction will be to new information. Only unexpected information should elicit a response from traders.
LOS 47. a: Describe market efficiency and related concepts, including their importance to investment practitioners.
Describe a fully efficient market
If the market is fully efficient, active investment strategies cannot earn positive risk-adjusted returns consistently, and investors should therefore use passive strategy.
LOS 47. b: Distinguish between market value and intrinsic value.
An asset’s market value is the price at which it can currently be bought or sold.
An asset’s intrinsic value is the price that investors with full knowledge of the asset’s characteristics would place on the asset.
LOS 47. c: Explain factors that affect a market’s efficiency.
Large numbers of market participants and greater information availability tend to make markets more efficient.
Impediments to arbitrage and short selling and high costs of trading and gathering information tend to make markets less efficient.
LOS 47. c: Explain factors that affect a market’s efficiency. In terms of market efficiency, short selling most likely:
Short selling promotes market efficiency because the sales pressure form short selling can reduce the prices of assets that have become overvalued.
LOS 47. d: Contrast weak-form, semi-strong-form, an strong-form market efficiency.
The weak form of the efficient markets hypothesis (EMH) states that security prices fully reflect all past price and volume information.
LOS 47. d: Contrast weak-form, semi-strong-form, an strong-form market efficiency.
The semi-strong form of the EMH states that security prices fully reflect all publicly available information.
LOS 47. d: Contrast weak-form, semi-strong-form, and strong-form market efficiency.
The strong form of the EMH states that security prices fully reflect all public and private information.
LOS 47. e: Explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management.
If markets are weak-form efficient
If markets are weak-form efficient, technical analysis does not consistently result in abnormal profits.
LOS 47. e: Explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management.
If markets are semi-strong form efficient
If markets are semi-strong form efficient, fundamental analysis does not consistently result in abnormal profits. However, fundamental analysis is necessary if market prices are the be semi-strong form efficient.
LOS 47. e: Explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management.
If markets are strong form efficient
If markets are strong-form efficient, active investment management does not consistently result in abnormal profits.
Even if markets are strong-form efficient, portfolio managers can add value by establishing and implementing portfolio risk and return objectives and assisting with portfolio diversification, asset allocation, and tax minimization.
LOS 47. f: Describe market anomalies.
What is a market anomaly
A market anomaly is something that deviates from the efficient market hypothesis. Most evidence suggests anomalies are not violations of market efficiency but are due to the methodologies used in anomaly research, such as data mining or failing to adjust adequately for risk.
LOS 47. f: Describe market anomalies.
What are examples of time-series data anomalies?
Anomalies that have been identified in time-series data include:
calendar anomalies such as the January effect (small firm stock returns are higher at the beginning of January),
overreaction anomalies (stock returns subsequently reverse), and
momentum anomalies (high short-term returns are followed by continued high returns).
LOS 47. f: Describe market anomalies. Cross-sectional data anomalies include:
Anomalies that have been identified in cross-sectional data include
a size effect (small-cap stocks outperform large-cap stocks) and
a value effect (value stocks outperform growth stocks).
LOS 47. f: Describe market anomalies. What are other examples of identified anomalies?
Other identified anomalies involve:
closed-end investment funds selling at a discount to NAV,
slow adjustments to earnings surprises,
investor overreaction to and long-term underperformance of IPOs, and
a relationship between stock returns and prior economic fundamentals.
