LA 6: Ch 4 R&B - Efficient Capital Markets Flashcards
What is the first premise of an efficient market?
Large # competing, profit-maximising participants who analyse and value securities, each independently of the others
What is the second premise of an efficient market?
New info regarding securities comes to market in random fashion
What is the third premise of an efficient market?
Profit-maximising investors cause security prices to adjust rapidly to reflect the effect of new information
What are the results of the premises of an efficient market?
- Security price changes should be INDEPENDENT and RANDOM
- prices that prevail at ANY time should be an UNBIASED REFLECTION of all CURRENTLY AVAILABLE INFO
- the EXPECTED RETURNS implicit in the current price of a stock should be CONSISTENT with perceived RISK of the stock
What are the general three Efficient Market Hypotheses?
- Random walk hypothesis
- Fair game model
- Efficient market hypothesis
What is the basic gist of random walk hypothesis?
Changes in security prices occur randomly i.e. they follow a random walk
What is the basic gist of fair game hypothesis?
Current MARKET PRICE reflects ALL AVAILABLE INFO about a security and the EXPECTED RETURN based upon this price CONSISTENT with its RISK
What is the three sub-hypotheses of the efficient market hypothesis?
Weak-form EMH
Semi-strong-form EMH
Strong-form EMH
What is the basic gist of Weak-form EMH?
Current prices reflect all security-market HISTORICAL INFO, incl. the historical sequence of
- prices
- rates of return
- trading volume data
- other market-generated info
i. e. prices reflect all historical information
What does Weak-form EMH imply?
Implies that PAST RATES OF RETURN and other MARKET DATA should have NO relationship with future rates of return
What is the basic gist of semi-strong-form EMH?
Current prices reflect all PUBLIC info, incl.
- market
- non-market info
i. e. all prices reflect all public information
What does semi-strong-form EMH imply?
Decisions made on NEW INFO after it is public SHOULD
NOT lead to ABOVE-AVERAGE RISK-ADJUSTED PROFITS from those transactions
What is the basic gist of strong-form EMH?
Stock prices FULLY reflect ALL INFO from public and private sources
i.e. prices reflect all public and private info
What does strong-form EMH imply?
Implies no group of investors should be able to consistently derive above-average risk-adjusted rates of return
What does strong-form EMH assume?
Assumes perfect markets in which all info is cost-free and available to everyone at the same time
What are the results of tests of Weak-form EMH?
- When pre-2000 trading costs were considered all the trading profits turned to losses. (recent lower trading costs could have a diff result)
- Testing results generally support the weak-form EMH but results not unanimous
Based on the results of return prediction studies on quarterly earnings reports, what is NOT instantaneously reflected in security prices?
(From tests of Semistrong-EMH)
Earnings price is not instantaneously reflected in security prices
Based on the results of return prediction studies on TIME SERIES TESTS FOR ABNORMAL RETURNS, what has been shown to be limited? What has been shown to be successful?
(From tests of Semistrong-EMH)
Short-horizon returns have limited results
Long-horizion returns analysis have been quite successful based on
- div yeld (D/P)
- default spread
- term structure
Quarterly earnings reports may yield abnormal returns due to
- unanticipated earnings change
What is the January anomaly?
From tests of Semistrong-EMH
Stocks with negative returns during the prior year had higher returns right after the first of the year
When does all the market’s cumulative advance occur?
From tests of Semistrong-EMH
During the first half of the trading months
What is different w.r.t. Monday/weekend returns in comparison to the rest of returns?
How does this effect affect large and small firms respectively?
(From tests of Semistrong-EMH)
They were significantly negative in the return prediction studies
Large firms: weekend effect - negative monday effect occured BEFORE the market opened
Small firms: most of effect occured during the day (i.e. monday trading effect)
What is the low and high price-earnings ratios shown to be correlated with? What is this inconsistent with?
(From tests of Semistrong-EMH)
Low P/E stocks experienced superior risk-adjusted results relative to market
High P/E stocks had significantly inferior risk-adjusted results
This is inconsistent with semistrong EMH
In the tests of how do stock splits and IPOs affect stock prices for semi-strong EMH what was shown?
Stock splits: splits result in abnormal gains before the announcement not after
IPO: underpriced by about 18% at offering (varies with time) & price is adjusted within one day
Do corporate insiders conform to strong-form EMH?
Not really, many insiders had above-average returns implying they had private info that the market did not
What did the tests of Security Analysts show? (Strong-form EMH)
Evidence in favour of existence of superior analysts who apparently posses private info
Why did they study Professional money managers?
- group that is most likely to achieve-above average returns
- non-insider group that is most likely to obtain inside information
What did the study of professional money managers yield in results w.r.t. strong-form EMH?
Some weak support for strong-from EMH
