MM34 Exam Group 1&2 Flashcards
-is when the actual result under a given set of assumptions is different from the expected result predicted by a model.
-provides evidence that a given assumption or model does not hold up in practice. The model can either be a relatively new or older model.
ANOMALY
Two common types of anomalies:
MARKET ANOMALIES
PRICING ANOMALIES
are distortions in returns that contradict theefficient market hypothesis(EMH).
MARKET ANOMALIES
are when something—for example, a stock—is priced differently than how a model predicts it will be priced.
PRICING ANOMALIES
Causes of anomalies in an efficient market
Mispricing
Limits to arbitrage
Unmeasured risk
Selection bias
is the ratio of a firm’s asset price to its fundamental value, which is the present value of future cash flows under rational expectations.
MISPRICING
is a theory in financial economics that, due to restrictions that are placed on funds that would ordinarily be used by rational traders to arbitrage away pricing inefficiencies, prices may remain in a non-equilibrium state for protracted periods of time.
Limits to arbitrage
In finance, risk factors are the building blocks of investing, that help explain the systematic returns in equity market, and the possibility of losing money in investments or business adventures.
Unmeasured risk
is the bias introduced by the selection of individuals, groups, or data for analysis in such a way that proper randomization is not achieved, thereby failing to ensure that the sample obtained is representative of the population intended to be analyzed.[1] It is sometimes referred to as the selection effect. The phrase “selection bias” most often refers to the distortion of a statistical analysis, resulting from the method of collecting samples
Selection bias
Several studies in markets across the world have yielded the following results. Stocks with below average price-to-earnings and market-to-book ratios have consistently outperformed growth stocks over a period of time. This is a contradiction of the semi-strong efficient market form as financial disclosures are used to beat the market consistently.
Value Effect
One study observed that on a risk-adjusted basis small-cap equities out-performed large cap equities. This anomaly was not observed in further studies and was therefore disregarded.
Size Effect
Other Anomalies
-Close-end investment fund
discounts
-Earning Surprise
-Initial Public Offerings
-Abnormal profits based on dividends
issues a limited number of shares during one offering, thus fixing the market capitalization till a second offering is made. In theory these shares must trade at their net asset value or NAV.
Close-end investment fund
discounts
Pricing anomalies studied in the context of adjustment of stock prices in relation to earnings announcement come under the purview of earning surprise.
Earnings Surprise
Companies avail the services of investment banks in pricing and marketing of their shares in their first stock market foray. As the entrants are new, their selling prices are set low and tend to see an increase on the first day of trading.
Initial Public Offerings
Market researchers state that equity returns are impacted by stock volatility, inflation, interest rates and dividend yields. This should indicate market inefficiency especially of weak form. This does not hold true though over a period of time. The relationship between stock prices and dividends has been found to vary from positive to negative from time to time.
Abnormal profits based on dividends
Types of Market Anomalies
The small- firm effect
Price reversals
January effect
The momentum effect
holds that smaller companies have a greater amount of growth opportunities than larger companies.
The small- firm effect
is also referred to as the mean reversion effect and refers to the tendency of stocks that have performed well in the past to underperform in the future, and the tendency of stocks that have underperformed in the past to outperform in the future
The price reversals
is a hypothesis that there is a seasonal anomaly in the financial market where securities’ prices increase in the month of January more than in any other month.
The january effect
refers to the market anomaly where stocks that have had the greatest return continue to outperform those with weak returns.
The momentum effect
Other type’s of Market anomalies
September Effect
Days of the Week Anomalies
Monday effect
refers to historically weakstock market returns for the month of September. There is a statistical case for the September effect depending on the period analyzed,but much of the theory is anecdotal
September Effect
is the type of anomalies that affect the stock returns to intimately tied to the day of the week.
Days of the Week Anomalies
is a theory which states that returns on thestock marketon Mondays will follow the prevailing trend from the previous Friday. Therefore, if the market was up on Friday, it should continue through the weekend and, come Monday, resume its rise. The Monday effect is also known as the “weekend effect.”
Monday effect
the branch of microeconomics that studies how information and information systems affect an economy and economic decisions.
or also called, INFORMATION ECONOMICS
Economic of Information
is the discipline of modeling the role of information in an economic system. Information is a strange good that is easy to create, difficult to validate, easy to share but difficult to unshare.
INFORMATION ECONOMICS
is a fundamental economic force that plays a role in every economic decision. Many economic models make naive assumptions about information such as the assumption that all economic agents have perfect information.
Information
14 Example of Information Economics
INFORMATION OF GOODS
Knowledge Economy
Risk & Uncertainty
Unknown Unknowns
Behavioral Economics
Expectations
Asymmetric Information
Incentives
Speculation
Private Information
Adverse Selection
Search Costs
Signalling
Screening
The value of information goods including data such as market data and knowledge such as a book.
INFORMATION OF GOODS
A global economic shift towards jobs that produce knowledge outputs such as strategies, plans, designs, specifications, instructions, data and computer code.
Knowledge Economy
Risk results from a lack of information about the future, also known as uncertainty.
Risk & Uncertainty
Risk can be identified, estimated and managed but unknown unknowns will remain.
Unknown Unknowns
Modeling how real people actually react to information
Behavioral Economics
Expectations that influence economic behavior.
Expectations
is when certain economic agents have an information advantage over others in a market.
Asymmetric Information
The information that is used to award economic agents such as the executive management of a firm.
Incentives
Economic agents who attempt to forecast the future to profit.
Speculation
Information as a competitive advantage such as a trade secret or patent.
Private Information
A situation where either the buyer or the seller have more information in a transaction.
Adverse Selection
The difficulty in finding information to make economic decisions. Decreases in search costs, such as the introduction of the internet, can make an industry far more competitive as it allows people to more easily evaluate prices and quality.
Search Costs
Firms often want to charge consumers different prices based on their willingness to pay but this information is difficult to determine.
is the process of trying to differentiate between customers based on their price sensitivity.
Screening
The communication of value in a market.
Signalling
The importance and value of information within economics is huge. It eliminates risk and uncertainty, and it makes it possible to take better choices that will report higher yields. The less risk and uncertainty there is, the higher the utility will be valued.
Importance of economic of information
occurs when one party in a transaction or
competitive situation has more information
than the other party.
Asymmetric Information
Two Forms of Asymmetric Information
- Adverse Selection
- Moral Hazards
occurs when buyers cannot
detect product quality prior
to purchase and use.
Adverse Selection
It is the action or announcements
conveying information about a firm’s
intentions or abilities.
Signals
occurs when the seller can
change the quality of their
offerings without detection
by buyers prior to the
purchase or trial.
Moral Hazards
TYPES OF QUALITY SIGNALS
Default-Independent Signals
Default-Contingent Signals
the seller incurs the signal cost
regardless of whether it fails to perform
as promised
Default-Independent Signals
the seller incurs the signal cost only
when they fail to perform as promised
Default-Contingent Signals
It is a promise made by the seller that
the product, or its performance-related
attributes, is free from defects in
materials and workmanship.
WARRANTIES
- Represents the value of the brand name to
the buyers - Brand name reduces buyers’ search and
information processing costs, and perceived
risk. - To be credible, maintain consistent marketing
and delivery of quality, - Advertising claims must be consistent with the
actual quality delivered
Brand Equity
A money-back guarantee promises
to return the buyer’s purchase
price if the product fails to satisfy
the buyer during the period
covered by the guarantee
GUARANTIES
It occurs when sellers can change
the quality of their offerings
without buyers’ detection before
purchase or trial.
Moral Hazards
Buyer’s willingness to pay a price
premium and their willingness and
ability to punish the seller if quality is
compromised, provide incentives to
solve this moral hazard problem.
Price Premiums
● Firms battle for the patronage of
customers, try to take business from a
rival, or seek to drive a competitor out
of the market.
● When competition is gaining in these
battles, price reductions occur leading
to price wars
Price Wars
