EMH

Question 1

Prices will reflect all available information quickly and accurately

Answer 1

Fama,1970

Question 2

Critique of Fama

Answer 2

Jensen,1978
Prices reflect information up to the point that marginal benefits received don’t exceed to the marginal cost of quoting and acting on the information.

Question 3

Test for Weak form

Answer 3

Return predictability tests- (Livermore,1923)

‘It never was my thinking that made me the big money. It was the sitting.’

Question 4

Evidence for strong

Answer 4

(Jaffa,1974)

Insiders do possess serial information and outsiders can profit

Question 5

Evidence against strong

Answer 5

(Shriller, 1981)

Stock prices are too volatile to be produced by rational investors

Question 6

Evidence against weak

Answer 6

Size effect, Banz 1981

Question 7

Size effect, Banz

Answer 7

1981- In the US smaller stocks outperformed large by 9%
Market mispricing smaller stocks
May not have been adjusted for risk

Question 8

Against emh- Law of one Price violated

Answer 8

Lamont and Thaler, 2003

Question 9

Lamont and Thaler

Answer 9

2003:

Royal Dutch petroleum merged with shell- 60/40 in 1907

Question 10

Royal Dutch petroleum/ Shell Merge

Answer 10

1907- 60/40 merge- royal Dutch should be worth 1.5x shell, but were valued 30% too low and shell 15% too high

Question 11

Test for semi strong

Answer 11

Event studies on news

Question 12

Evidence against semi strong

Answer 12

P/e effect- low p/e perform 6% better

Question 13

Against emh- Arguments against arbitrage

Answer 13

Markets must be inefficient or they’d never profit
Not all shares have a perfect substitute- to long and short
Behavioural finance- investors are rational profit maximisers- not true- moral hazard- mental short cuts

Question 14

Argument against arbrutage- behaviour finance- link to bubbles

Answer 14

Unrational behaviour buying in mania phase when likely the price will fall e.g tulip mania