Chapter 11 - The Efficient Market Hypothesis Flashcards
What is a random walk?
Price changes should be random and unpredictable - random stock prices are as a result of investors competing to discover new information
What does the Efficient Market Hypothesis state?
Stocks reflect all available information which is incorporated into the price.
What does weak-form EMH assert?
That stock prices already reflect all information that can be derived from examining market trading data such as history of past prices, trading volume, or short interest. This form implies that trend analysis is fruitless. The weak-form hypothesis holds that if ever such data conveyed reliable signals about future performance, all investors already would have learned to exploit the signals.
What does semi-strong EMH state?
All publicly available information regarding the prospects of a firm must already be reflected in the stock price.
What is strong-form EMH?
Stock prices reflect all information relevant to the firm, including informational available only to a few company insiders.
What is technical analysis?
The search for recurrent and predictable patterns in stock prices. Recognises the value of information regarding future economic prospects of the firm they believe such information is not necessary for a successful trading strategy. This is because whatever the fundamental reason for the change in stock price, if the stock price responds slowly enough the analyst will be able to identify a trend that can be exploited during the adjustment period.
What is a resistance or support level?
Commonly heard components of technical analysis, these values are said to be price levels above which it is difficult for stock prices to rise, or below which it is unlikely for them to fall, which are believed to be determined by market psychology.
What is fundamental analysis?
Uses earnings and dividend prospects of the firm, expectations of future interest rates and risk evaluation to determine proper stock prices. Ultimately represents an attempt to determine the present discounted value of all the payments a stockholder will receive from each share of stock.
What determines investor stock preference?
Tax brackets - higher tax bracket investors may wish to hold municipal bonds - lower tax bracket individuals this won’t be as attractive. Capital gains? Deter gains until lower tax bracket?
What is the cumulative abnormal return?
Sum of all abnormal returns over the time period of interest?
What are leakages?
When information prior to positive events “leaks” to a select few individuals leading to abnormal returns in the days preceding announcement - evidence of insider trading
What is serial correlation of stock market returns?
the tendency for stock returns to be related to past returns
What is negative serial correlation?
Positive returns tend to be followed by negative returns
What is a fads hypothesis?
Stock markets might overreact to relevant news which can lead to positive serial correlation (momentum) over short time horizons. Subsequent correction leads to poor performing firing good performance and visa versa
What is the reversal effect?
Losers rebound and winners fade back - suggesting the markets overreaction to news. After the overreaction is recognised, extreme investment performance is reversed.
