EMH

Question 1

What is the EMH?

Answer 1

• Securtities are priced efficients with respect to the avaialbe information, their prices reflect best avaiable forecast of expected benefits from future cash flows capitalised at discount rates.
• All expected rates of return are consistent with their perceived risk.
• Share prices reflect all currently available information, and that new information is rapidly assimilated into the price.
• iF markets are inefficent information is reflected only slowly in market prices, if at all.
• If capital markets are efficient this also tells us something about how easy or difficult it may be to make portfolio returns that are above market averages.

Question 2

What are EMH assumptions?

Answer 2

• Large number of profit maximising particpants who analyse and value securites independently of one another.
• New information regarding securtities arrives to the market randomly.
• New information must be unpredictable and random otherwise it would not be new information.
• Profit maximising investors adjust security prices rapidly to reflect the effect of new information.
• Dealing costs are not too high.
• Relevant information is avaiable to a sufficient number of investors and that no individual particpant are of sufficent wealth that they can in any sense dominate the market.

Question 3

What is the weak form of EMH?

Answer 3

• States that all information can be discovered from past price movements has already been incorporated into the share price.
• Implies that it should not be possible to predict future price movements from past price movements, or to produce superior returns on the basis of past information, since any such information from past prices has already been taken into the current price.
• Ignores forward looking information
• Should not be able to outperform market portfolio using investment process based on technical charting.
• Supported by evidence but there are anomalies - style based invest can work.
• Weak form of market efficiency is consistent with all forms of active management.

Question 4

What is semi-strong form of EMH?

Answer 4

• Market prices reflect all past info but also any information published about a company, i.e. all publicaly avaiable information.
• Allows for directors and other insiders of the business to have superior level of knowledge and hence to have an advantage.
• Insiders can therefore beat the market
• Fewer pricing anomalies for active management to exploit making it very difficult to outperform even with factor strategies.
• However, anomalies such as pre and post announcment drift happen.
• Investment style of copying directors buying and selling seems to work.
• Broker recommendation do not work and nor do active management which provides support.

Question 5

What is the strong form of EMH?

Answer 5

• Share prices fully reflect all information public or private.
• No investor will ever be able to make better than average returns, except through luck.
• Impossible for even the most corrupt investor to find out anything which the share price did not already reflect
• Indexation strategies are most profitable
• Most disconfirmed
• Long term directs traders are profitable, especially buys.

Question 6

What are the main market anomolies?

Answer 6

• Momentum:
  
  • Strongest evidence is momentum, which in the short run is a continuation strategy due to herd instinct, social biases, base rate neglect and company postive and negative news management.
  • Momentum runs out in the long run and previous winners underperform.
• Directors trades:
  
  • The strongest evidences if following directors trades, especially purchases and bundled purchases by more than one director.
• Low volatility:
  
  • Relatively new recent factors and lacks strong, long-run emprical academic underpinning.
  • Low vol stock might have other factors such as high dividend, low beta, low pe and non-cyclical which might give a factor tilts.
  • The return to low vol is also dependent on market regime rather than short or long term.