Efficient market hypothesis

Question 1

What does the EMH say about:

• All available info?
• Possibility of Earning excess returns?
• How information is disseminated?
• Predicting price changes using current info

Answer 1

• Current prices reflect all available information
• It’s impossible to earn excess returns using information that is publicly available
• Information is rapidly and accurately dissemenated
• It is not possible to predict price changes by using current information

Question 2

What is the Martingale property?

Answer 2

Prices in the next period given current information should be the same as current prices

Question 3

What is fair game?

Answer 3

Expected value is zero

Question 4

Why do cycles self destruct?

Answer 4

As soon as they are recognised by investors the stock price instantly jumps to the present value of expected future price

Question 5

What info is available in weak, semi strong, and strong form market efficiency?

Answer 5

Weak form - All current and past info on prices and returns, market trading data
Semi strong - All current and past public information
Strong form - All current and past information, public or private

Question 6

What is the EMH paradox?

Answer 6

When we consider why investors spend money looking for inefficiency if the market is efficient

Question 7

Up until what point do investors spend money on information?

Answer 7

Until the marginal cost of gathering and processing info is equal to the marginal benefit

Question 8

What is the challenge for fundamental analysts?

Answer 8

To perform an analysis that is better than that of anyone else

Question 9

What does the EMH imply about institutional vs other investors?

Answer 9

Professional managers have no informational advantages over other investors

Question 10

What does EMH imply about buy and hold returns vs active?

Answer 10

Buy and hold should ourperform active investment due to lower transaction costs

Question 11

What factors may cause an investor’s optimal portfolio to vary?

Answer 11

• Age
• Tax bracket
• Risk aversion

Question 12

If assets are mispriced, what happens to signals regarding the assets?

Answer 12

The signals are incorrect

Question 13

What are the three main areas of disagreement between academics and market analysts?

Answer 13

• The magnitude issue
• The selection bias issue
• The lucky event issue

Question 14

What is the Magnitude issue?

Answer 14

Small opportunities will exist to make abnormal profits, even if
prices are very close to fundamental value.

Question 15

What is the Selection Bias issue?

Answer 15

Published techniques may not work but effective private

techniques may exist.

Question 16

What is the Lucky event issue?

Answer 16

Abnormal performance is only evidence of inefficiency if it is
persistent over time

Question 17

What are correlation tests of a stock’s return?

Answer 17

Tests of short-term predictability examine whether return in
the prior period (usually a day or days) can predict today’s
return.