wk3 Flashcards
characteristics of stock returns
-volatility = more volatile more needs to hit higher returns
-are returns predictable = looking at historical data and observing pattern in data
-what types of stock have highest returns = getting as much return as possible
Properties stock prices have in efficient markets
- random and unpredictable so should no historical data to observe
- asset prices should react quickly to new information, how is market absorbing information
- investors should not be able to earn abnormal profits or abnormal risk-adjusted returns
predictable stock price
up and down fluctuations, cyclical movement present but movements are predictable will know when stock prices will fall or rise
systematic risk
market risk and non-diversifiable risk
idiosyncratic risk
firm or asset specific, diversifiable risk
What causes asset price volatility?
- natural disasters, political unrest, economic conditions (recession/ depression), inflation and demand and supply conditions
- Fear and panic where mass buying and selling not driven by market or firm conditions
- pandemic had huge drops in major markets, investors nervous, prices fell further and so big opportunity for buying
- pandemic saw increase in first time investors as more time and more disposable income
- most volatile sectors include energy, commodities and financial
- more stable sectors include utilities
what is profit equal to
dividends + capital gains
what does constant risk mean
when zero level risk future value is known and so is predictable
what does random variable mean
return that is volatile and moves around future value is unknown making it unpredictable and uncertain
what are most asset returns random or constant?
all asset returns are random variables as some level of volatility in all of them either high or low in risk
what is the reality of markets?
unpredictable we dont know a lot about them
such as when prices rise or fall
what are the main issues of stock market efficiency?
- magnitude issue → stock prices be close to fair value only managers or large portfolios can earn enough trading profit from mispricing
- people only with large amount of certain stocks can take advantage of mispricing
- possible for mispricing to be observed where information is available
- selection bias issue → who discovered investment strategies generate abnormal returns unlikely to share them
- lucky even issue → many investors using variety of strategies some investors will be lucky so winners are expected
how to measure stock market efficiency
using maths markets tested as finance and economics academics done a lot of research on it
covariance what is it
measure degree to which variables move together
what does it mean when positive covariance
variables moving in same direction
what does it mean when negative correlation
move in opposite directions
how can portfolio diversification be created?
-different assets from different classes
- different sectors and industries such as natural resources, health, finance, tech
- invest in different sectors as will have different sources of risks
- size of firms investing in so larger established firms or smaller firms
- domestic vs international
- developed markets only?
- or developed combined with emerged and developing
what are the 4 types of stock market anomalies?
- size effect → small stocks outperform larger stocks especially in Jan
- jan effect → returns in this month abnormally high, buy and sell decisions motivated by tax purposes instead of changes in demand and supply conditions
- value effect → low price to book stock outperform high price-to-book stocks
- momentum → stocks with high returns over 12 months continue to outperform stocks with low past returns
