Market efficiency Flashcards
What is an informationally efficient capital market?
A market where current prices reflect all available information quickly and rationally.
This concept implies that prices are unbiased estimates of their true values.
What is the implication of a perfectly efficient market for investment strategies?
Investors should use passive investment strategies, such as buying broad market index stocks.
Active strategies may underperform due to transaction costs and management fees.
How is market efficiency measured?
By determining the lag time for trading activity to reflect information in security prices.
In efficient markets, this lag can be very short, such as one minute.
What should affect market prices according to market efficiency?
Only new information that is unexpected and changes expectations should move prices.
Anticipated information should not impact prices.
Define market value.
The current price of an asset.
It reflects what investors are willing to pay at any given time.
Define intrinsic value.
The value a rational investor would pay based on full knowledge of an asset’s characteristics.
This includes factors like coupon, maturity, and risk.
What happens in markets that are not completely efficient?
Active managers can buy undervalued assets and sell overvalued assets.
This is based on the belief that intrinsic values differ from market values.
List factors affecting market efficiency.
- Number of market participants
- Availability of information
- Access to information
- Impediments to trading
- Transaction and information costs
Each of these factors can enhance or diminish market efficiency.
What is weak-form market efficiency?
Current prices reflect all past market data, making technical analysis ineffective.
Price changes are independent from one period to the next.
What is semi-strong-form market efficiency?
Prices adjust to all publicly available information, negating the effectiveness of fundamental analysis.
This includes past market data and non-market public information.
What is strong-form market efficiency?
Prices reflect all information, both public and private, denying any group monopolistic access to information.
Evidence suggests markets do not fully reflect private information due to insider trading regulations.
What is the implication of semi-strong form efficiency for portfolio management?
Investors should prefer passive investment strategies like index funds.
Most mutual fund managers fail to outperform passive strategies over time.
What is a market anomaly?
A deviation from the expected norms that could lead to rejecting market efficiency hypotheses.
Anomalies suggest potential profitable strategies based on historical data.
What is the January effect?
A calendar anomaly where stock returns, especially for small firms, are higher during the first five days of January.
This may be influenced by tax-loss selling and window dressing.
What is the overreaction effect?
Firms with poor past returns tend to have better subsequent returns, while those with high past returns may underperform.
This indicates a violation of weak-form market efficiency.
Define the size effect.
The initial finding that small-cap stocks outperform large-cap stocks, though later studies could not confirm this.
This suggests potential random results or market adjustments.
What is the value effect?
The observation that value stocks outperform growth stocks, contradicting semi-strong form efficiency.
This relationship is based on publicly available information.
What is the significance of closed-end investment funds?
Their shares often trade at significant discounts to net asset value (NAV), suggesting market inefficiencies.
Various factors like fees and illiquidity contribute to this anomaly.
What is an earnings surprise?
The portion of earnings announcements that was unexpected by the market, leading to predictable stock return patterns.
Positive surprises lead to positive returns, while negative surprises result in negative returns.
What is an earnings surprise?
The portion of announced earnings that was not expected by the market.
What typically follows a positive earnings surprise?
Periods of positive risk-adjusted post-announcement stock returns.
What is the outcome of a negative earnings surprise?
Predictable negative risk-adjusted returns.
True or False: The adjustment process for earnings surprises occurs entirely on the announcement day.
False.
How can investors exploit earnings surprises?
By buying positive earnings surprise firms and selling negative earnings surprise firms.
