LM 3: Market Efficiency Flashcards
What is an informationally efficient market?
market were prices reflect all past & present information
What are 4 things affecting market efficiency? MILT
- market participants
- information availability & financial disclosure
- limits to trading
- transaction costs & information acquisition costs
What is the performance difference between an efficient market and an inefficient market?
efficient market cannot get consistent, superiors risk adjusted returns
inefficient market can outperform on a risk adjusted basis
What kind of information should efficient markets react too?
efficient markets should only react to unexpected information, expected news is already built into prices
What are the 3 degrees of market efficiency?
- weak
- semi-strong
- strong
What information is reflected in prices in a weak form market efficiency?
past market data (price and trading volume)
What information is reflected in prices in a semi-strong market efficiency?
public information & past market data (past price and trading volume information)
What information is reflected in prices in a strong market efficiency?
private information, public information, and past market data
Using technical analysis shows what kind of market efficiency?
weak form
What kind of market efficiency does fundamental analysis support?
semi-strong form
What kind of market efficient do portfolio managers benefit from?
none, studies show active portfolio managers do not beat the market on average. however, good to create an investment strategy based on ones objectives and constraints
What is a market anomaly?
change in a security’s price that cannot be attributed to new information.
What are 2 types of time series anomalies?
- calendar anomalies
- momentum & overreaction anomalies
What are calendar anomalies?
Anomalies that are linked to a particular time (eg. January effect)
What is momentum & overreaction anomalies?
momentum anomaly: observed tendency for rising asset prices to rise further and falling prices to keep falling.
overreaction anomaly: securities become excessively overbought or oversold due to psychological reasons rather than fundamentals.
What are 2 types of cross sectional anomalies, describe them?
- size effect (small cap outperformed big cap on risk adjusted basis)
- value effect (the observation that stocks with attractive valuations tend to outperform the market in the long term)
What are 4 other market anomalies besides time series & cross sectional? CEIP
- closed end investment fund discounts
- earnings surprise
- IPO
- predictability of returns based on prior information
What is closed end investment fund discounts anomaly?
Shares of closed-end funds trade on stock markets like other equity securities, but at a discount to their net asset value (NAV)
What is earnings surprise anomaly?
companies with positive surprise earnings announcements experience a prolonged period of abnormal positive security returns
What is initial public offerings anomaly?
companies that issue IPOs tend to set low offering prices so earn excess returns by purchasing IPO at offering price
What is Predictability of Returns Based on Prior Information anomaly?
equity returns are linked to factors including interest rates, inflation rates, volatility, and dividend yields.
What is one implication you must consider with market anomalies?
trading costs
What is behavioral finance?
Behavioral finance: area of study that proposes psychology-based theories to explain market outcomes and anomalies.
What are 8 behavioral finance biases that can cause or explain anomalies? LHOIRMCN
- loss aversion
- herding
- overconfidence
- information cascades
- representativeness
- mental accounting
- conservatism
- narrow framing