Investment anomalies and return predictability Flashcards
What are the most famous and important anomalies?
1) Reversal and momentum effect
2) Post earnings announcement drift
3) Market predictability
4) Size and vlaue
If you discover an anomaly, then you realise your anomaly disappears, was it an anomaly in the first place?
No there wasn’t an anomaly in the first place, it was driven by data mining or investors fastly eliminated this opportunity. Finally, market fricitions - investors cannot take short positions because its very costly.
What is reversal?
is a market phenomenon where stocks that have experienced recent price declines tend to outperform those with recent price increases in the short term.
What form of efficiency does reversal ( loses rebound and winners fade back) violate and how?
The reversal anomaly contradicts weak form efficiency, which asserts that stock prices should reflect all past trading information and not exhibit predictable patterns. This anomaly suggests that investors might profit from short-term trading strategies based on past price movements, challenging the weak form of market efficiency.
Why might reversal happen.
Overreaction occurs when investors respond excessively to recent news or events, causing temporary stock mispricing. Prices may revert to their intrinsic value as the market self-corrects.
How does this show reversal?
so this shows the return of the portfolio that takes a long position in losers and short position in winners, these portfolios have positive returns, so loser portfolios start outperforming winner portfolios.
What is the momentum anomaly?
that stocks with strong past performance (winners) tend to continue performing well in the short term, while stocks with weak past performance (losers) continue underperforming. This strategy involves buying winners and shorting losers
What form of efficiency does momentum violate and how?
It violates weak form efficiency. Momentum violates weak form efficiency as it demonstrates that past price movements can predict future performance, contradicting the idea that current prices fully incorporate all available historical information.
This table shows different strategies of longing and shorting for different holding periods k. what do we see?
It shows a profitable investment strategy to buy ( winner portfolios and short losers)
What is the anonomaly Earnings announcement puzzle?
The earnings announcement puzzle is a market anomaly where stock prices tend to drift in the same direction as the earnings surprise (either positive or negative) for an extended period after the announcement, rather than adjusting immediately to the new information.
What form of efficiency does earnings announcement puzzle contradict and why?
The earnings announcement puzzle contradicts the semi-strong form of the efficient market hypothesis, which assumes that all publicly available information, including earnings announcements, should be immediately reflected in stock prices, and suggests that the market is not reacting efficiently to new information, violating the semi-strong form efficiency.
What is the twin stocks puzzle anomaly AND what form of efficiency does twin stock puzzle violate?
The twin stocks puzzle refers to a market anomaly where two stocks with very similar or virtually identical cash flows ( often from companies that are subsidiaries of the same parent company ) and risks trade at significantly different valuations. This phenomenon contradicts the Law of One Price, which suggests that two assets with the same risk and return characteristics should be priced identically.
It violates semi-strong form efficiency.
What is the bubble anomaly?
The bubble anomaly is a deviation from the efficient market hypothesis, particularly the semi-strong and strong forms, where the price of an asset significantly exceeds its intrinsic value due to irrational exuberance and speculative behavior among investors, often driven by herd behavior(buying into an asset based on the expectation that its price will continue to rise, rather than on a rational assessment of the asset’s underlying value) , and eventually leads to a rapid decline in the asset’s price when recognized as unsustainable.
What is the size effect anomaly and how does it contradict ETH? what about book to market ( value effect)
smaller firms generate higher risk-adjusted returns than larger firms, contradicting the efficient market hypothesis, suggesting that investors can systematically outperform the market by investing in smaller companies.
The value effect, or book-to-market effect, suggests that value stocks (high book-to-market ratios) outperform growth stocks (low book-to-market ratios) in the long term, indicating that value stocks are undervalued ( REASON FOR THIS) , and investors can achieve superior risk-adjusted returns by investing in them.
What is a rational explanation why value stocks offer higher returns?
they may be riskier than growth stocks, and therefore require a higher return to compensate investors for the additional risk. ( they have high distress risk, hence mv low)
The monthly rate of return on T-bills is 1%. The market went up this month by 1.5%. AmbChaser, Inc. (AC), which has an equity beta of 2, surprisingly just won a lawsuit that awards it $1 million immediately. If the original value of AC equity were $100 million, what would you guess was the rate of return of its stock this month?
To calculate the returns for a portfolio long in the small stocks and short in the large stocks.
