BKM 11 Flashcards
Random walk
Stock price changes should be random and unpredictable
Efficient market hypothesis
The notion that stocks already reflect all available information
Weak-form hypothesis
Stock prices already reflect all information that can be derived by examining market trading data such as history of past prices, trading volume, or short interest.
Trend analysis is fruitless.
Semistrong-form hypothesis
All publicly available information regarding the prospects of a firm must be already reflected in a stock’s price
Strong-form hypothesis
Stock prices reflect all information relevant to the firm, even including information available only to company insiders.
Quite an extreme
Technical analysis
Search for recurrent and predictable patterns in stock prices
Resistance/support levels
Above which it is difficult for stock prices to rise, or below which it is unlikely for them to fall
Believed to be determined by market psychology
EMH and technical analysis
EMH implies technical analysis is without merit
Fundamental analysis
Uses earnings and dividend prospects of the firm, expectations of future interest rates, and risk evaluation of the firm to determine proper stock prices
EMH and fundamental analysis
Most fundamental analysis is doomed to failure
Passive investment strategy
Makes no attempt to outsmart the market; proponents of EMH prefer this strategy as other efforts are wasted
Index fund
Fund designed to replicate performance of a broad-based index of stocks
Role for portfolio management in efficient market
Tailor portfolio to investor needs depending on factors such as age, tax bracket, aversion, etc.
Event study
Technique of empirical financial research that enables observers to assess the impact of a particular event on a firm’s stock price
Abnormal return (definition)
Difference between actual stock return and a benchmark
Abnormal return (formula)
e(t) = r(t) - a + br(M(t))
a = average rate of return with zero market return
Cumulative abnormal return
Sum of all abnormal returns over a given time period; event studies could be complicated due to leakage of information
SEC and availability of information
Dramatic increase in value with announcement date indicates these are indeed news to the market, not already reflected in the price
Three factors the imply EMH does not hold
Magnitude Issue
Selection Bias Issue
Lucky Event Issue
Magnitude issue
Small percentage increase could be large $-wise based on size of portfolio
Selection bias issue
Only investors who find an investment scheme that does not generate abnormal returns will report findings
Lucky event issue
Any bet on a stock is a coin toss, given EMH
Ex: Coin-flipper with 75% heads
Weak-form tests
Patterns in stock returns
Serial correlation
Tendency for stock returns to be related to past returns; positive over short horizons
