Chapter 11 Flashcards
Capital Market Research explores ..
the role of financial accounting and other information in equity markets. Involves examining statistical relations between information and share prices
No price change around the time of the release of information implies…
no reaction to the information (no information content)
Why do the capital markets react so quickly to information?
The arbitrage mechanism - if there is imbalance in market price, people will exploit the imbalance and buy/sell shares
The 2 questions often asked by capital markets researchers:
- What is the impact of the release of accounting information on share returns?
- Which accounting information is relevant for valuing shares in a company?
Underlying assumptions of CMR - EMH
CMR relies on the assumption that equity markets are efficient in accordance with the Efficient Market Hypothesis (EMH)
An efficient market is defined as…
a market that adjusts rapidly to fully impound information into share prices when the information is released
Perspectives on efficient market hypothesis
- semi-strong - prices reflect all publicly available information and the price changes to reflect new information
- weak-form - current prices on traded assets already reflects all prior publicly available information. Future prices can not be predicted through analysing new information
- strong-form - prices reflect all publicly available information and the prices changes immediately
Share prices react to information from various sources
- profits (accounting data)
- news about senior executive resignations
- takeover rumours
- concerns raised by auditors
- industry-wider changes
What are event studies?
Studies that look at changes in share prices around a particular event, such as the release of accounting information.
Relation earnings and return
Share prices are the sum of expected future cash flows from dividends, discounted to their present value using a rate of return commensurate with the company´s risk. Unexpected earnings are expected to be associated with change in share price
The Market Model - use
Used to separate out firm-specific share price movements from marketwide movements, derived from the Capital Asset Pricing Model. Assumes investors are risk averse and have homogeneous expectations
The Market Model - total or actual returns can be divided into:
- normal (expected) returns given market-wide movements
- abnormal (unexpected) returns due to firm-specific share price movements –> indicators of information content of announcements
Retrns are a function of share price - Calculation return
Return = (End price + dividends - Beginning price) / Beginning price
Value-relevance research
Accepts that particular information, including financial accounting information, is deemed to be “value-relevant” if there is a significant statistical relationship between the information and the market value of the company´s equity.
- Assumes the market is efficient and acknowledges that financial statements are NOT the only source of information
