TWO PILLARS OF ASSET PRICING Flashcards
What are the three forms of market efficiency according to the Efficient Market Hypothesis (EMH)?
The three forms of market efficiency are weak, semi-strong, and strong, each reflecting different levels of information reflection in asset prices.
What is the joint hypothesis problem (JHP) and why is it relevant in testing market efficiency?
The joint hypothesis problem arises when testing market efficiency because if the test rejects the efficient market hypothesis (EMH), it’s unclear whether the market is truly inefficient or if the chosen asset pricing model is inadequate.
What evidence supports the Efficient Market Hypothesis (EMH) according to Fama et al. (1969)?
Fama et al. (1969) found that stock splits resulted in no further reaction in stock prices after the split, supporting the idea that all implications of the split were already incorporated into stock prices beforehand.
What do Fama and French (1989) find regarding the predictability of stock returns based on business conditions?
Fama and French (1989) find that expected returns are high when business conditions are poor and low when they are strong, suggesting a correlation between business conditions and stock returns.
How do volatility of dividends and stock price swings relate to the Efficient Market Hypothesis (EMH)?
The volatility of dividends is deemed insufficient to explain stock price volatility according to Shiller (1981), but Fama defends EMH by attributing predictability to rational factors rather than irrational swings away from fundamental values.
What is Fama’s perspective on the concept of a “bubble” in asset markets?
Fama questions the definition of a “bubble” and suggests that large swings in stock prices are responses to real economic activity rather than irrational speculation, consistent with market efficiency.
What are the two types of asset pricing models discussed in the paper?
The two types of asset pricing models discussed are standard asset pricing models, which start from assumptions about investor preferences, and empirical models, which propose models based on observed patterns in average returns.
