Week 5 Market efficiency Flashcards
What is the definition of an efficient market?
Market that efficiently processes Information
Current prices are correct valuations that reflect all information available
What is the revised Efficient market Hypothesis?
Prices reflect all information to te point where the marginal benefit of acting on information does not exceed marginal cost
What are the types of information?
Are they included in share prices?
- Old information = Always included
- Public information = likely included
- Private information = unlikely included
What are the different typologies of Efficient markets?
Weak-form-efficiency
- Prices reflect information implicit in past return patterns
Semi-Strong efficacy
- Prices reflect publicly available information
Strong-form Efficiency
- Prices reflect public and private information
What is the “wisdom of the crowd” theory?
What are its critiques?
Wisdom of the crowd theory is the idea that prices are the greatest sources of value information and that the market as a whole holds more information than any one person.
Critiques:
Prices can reflect personal preference
Cashflows are unpredictable
What are the risks to arbitrageurs
- Fundamental risk
- Additional information is released and prices swings against prediction - Noise trader risk
- Sheer number of irrational investors can overpower the artibitrageurs - Implementation risk
- transaction costs
- wide bid spread
- costs of market research
What is the joint hypothesis problem
The two hypothesis:
1. our model is correct and observed price is wrong
2. Our model is wrong and the observed price is right
What are the anomalies to Efficient market theory?
- Markets overreact to news
- Momentum effect
- Winner win and loser lose (badly) - Profitability
- Firms with higher gross margins earn higher returns - Investment Factor
- Firms that invest conservatively earn higher returns
