Book 3_Equity_READING 43_MARKET EFFICIENCY

Question 1

In an informationally efficient capital market

Answer 1

• Security prices reflect all available information fully, quickly, and rationally
• Only unexpected information should elicit a response from traders.

Question 2

If the market is fully efficient,

Answer 2

Active investment strategies cannot earn positive risk adjusted returns consistently, and investors should therefore use a passive stratege because of transactions costs and management fees.

Question 3

An asset’s intrinsic value

Answer 3

the price that investors with full knowledge of the asset’s characteristics would place on the asset.

Question 4

Markets more efficient if

Answer 4

Large numbers of market participants and greater information availability

Question 5

markets less efficient because

Answer 5

• Impediments to arbitrage and short selling
• High costs of trading and gathering information

Question 6

The weak form of the efficient markets hypothesis (EMH)

Answer 6

• Security prices fully reflect all past price and volume information
• Technical analysis does not consistently result in abnormal profits.

Question 7

The semi-strong form of the EMH

Answer 7

• Security prices fully reflect all publicly available information.
• Fundamental analysis does not consistently result in abnormal profits. However, fundamental analysis is necessary

Question 8

The strong form of the EMH

Answer 8

• Security prices fully reflect all public and private information.
• Active investment management does not consistently result in abnormal profits.

Question 9

A market anomaly

Answer 9

is something that deviates from the efficient market hypothesis due to:
- the methodologies used in anomaly research, such as data mining or failing to adjust adequately for risk.

Question 10

Anomalies that have been identified in time-series data

Answer 10

• 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)

Question 11

Anomalies that have been identified in cross-sectional data

Answer 11

• a size effect (small-cap stocks outperform large-cap stocks)
• and a value effect (value stocks outperform growth stocks).

Question 12

Other identified anomalies

Answer 12

• closed-end investment funds selling at a discount to NAV,
• slow adjustments to earnings surprises,
• investor overreaction to and longterm underperformance of IPOs,
• and a relationship between stock returns and prior economic fundamentals.

Question 13

Behavioral finance

Answer 13

• Examines whether investors behave rationally, how investor behavior affects financial markets, and how cognitive biases may result in anomalies.
• Behavioral finance describes investor irrationality but does not necessarily refute market efficiency as long as investors cannot consistently earn abnormal risk-adjusted returns.

Question 14

irrational behavior

Answer 14

• Loss aversion
• Investor overconfidence
• Herding

Question 15

Herding

Answer 15

which is a tendency of investors to act in concert on the same side of the market, acting not on private analysis, but mimicking the investment actions of other investors.

Question 16

An information cascade

Answer 16

results when investors mimic the decisions of others. The idea is that uninformed or less-informed traders watch the actions of informed traders and follow their investment actions.