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    Chapter 008

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    1) The document discusses the efficient market hypothesis and whether stock prices fully reflect all available public information. It examines evidence from studies of market anomalies and patterns in stock returns. 2) While some studies find market inefficiencies, others argue these anomalies can be explained by risk factors. There is also a debate around whether apparent predictive returns are true signals or results of data mining. 3) Studies on mutual fund managers and stock analysts performance have found mixed evidence as to whether they can consistently outperform the market and add value.

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    Chapter 008

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    cilrabbi
    17 views35 pages
    1) The document discusses the efficient market hypothesis and whether stock prices fully reflect all available public information. It examines evidence from studies of market anomalies and patterns in stock returns. 2) While some studies find market inefficiencies, others argue these anomalies can be explained by risk factors. There is also a debate around whether apparent predictive returns are true signals or results of data mining. 3) Studies on mutual fund managers and stock analysts performance have found mixed evidence as to whether they can consistently outperform the market and add value.

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    1) The document discusses the efficient market hypothesis and whether stock prices fully reflect all available public information. It examines evidence from studies of market anomalies and patterns in stock returns. 2) While some studies find market inefficiencies, others argue these anomalies can be explained by risk factors. There is also a debate around whether apparent predictive returns are true signals or results of data mining. 3) Studies on mutual fund managers and stock analysts performance have found mixed evidence as to whether they can consistently outperform the market and add value.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    17 views35 pages

    Chapter 008

    Uploaded by

    cilrabbi
    1) The document discusses the efficient market hypothesis and whether stock prices fully reflect all available public information. It examines evidence from studies of market anomalies and patterns in stock returns. 2) While some studies find market inefficiencies, others argue these anomalies can be explained by risk factors. There is also a debate around whether apparent predictive returns are true signals or results of data mining. 3) Studies on mutual fund managers and stock analysts performance have found mixed evidence as to whether they can consistently outperform the market and add value.

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    of 35

    CHAPTER 8

    The Efficient Market


    Hypothesis

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.


    8.1 RANDOM WALKS AND THE
    EFFICIENT MARKET HYPOTHESIS

    8-2
    Efficient Market Hypothesis (EMH)

    Do security prices reflect information


    Why look at market efficiency
    – Implications for business and corporate
    finance
    – Implications for investment

    8-3
    Random Walk and the EMH

    Random Walk - stock prices are random


    – Randomly evolving stock prices are the
    consequence of intelligent investors
    competing to discover relevant information
    Expected price is positive over time
    Positive trend and random about the trend

    8-4
    Random Walk with Positive Trend
    Security
    Prices

    Time 8-5
    Random Price Changes

    Why are price changes random


    – Prices react to information
    – Flow of information is random
    – Therefore, price changes are random

    8-6
    Figure 8.1 Cumulative Abnormal Returns
    Before Takeover Attempts

    8-7
    Figure 8.2 Stock Price Reaction to CNBC
    Reports

    8-8
    EMH and Competition

    Stock prices fully and accurately reflect


    publicly available information
    Once information becomes available,
    market participants analyze it
    Competition assures prices reflect
    information

    8-9
    Versions of the EMH

    Weak
    Semi-strong
    Strong

    8-10
    8.2 IMPLICATIONS OF THE EMH

    8-11
    Types of Stock Analysis

    Technical Analysis - using prices and volume


    information to predict future prices
    – Weak form efficiency & technical analysis
    Fundamental Analysis - using economic and
    accounting information to predict stock prices
    – Semi strong form efficiency & fundamental analysis

    8-12
    Implications of Efficiency for Active or
    Passive Management

    Active Management
    – Security analysis
    – Timing
    Passive Management
    – Buy and Hold
    – Index Funds

    8-13
    The Role of Portfolio Management in
    an Efficient Market

    Even if the market is efficient a role


    exists for portfolio management:
    – Appropriate risk level
    – Tax considerations
    – Other considerations

    8-14
    8.3 ARE MARKETS EFFICIENT

    8-15
    Empirical Tests of Market Efficiency

    Magnitude Issue
    – Actions of intelligent investment managers are the
    driving force
    Selection Bias Issue
    – The outcomes we observe have been preselected in
    favor of failed attempts
    – Cannot evaluate the true ability of portfolio
    managers
    Lucky Event Issue

    8-16
    Weak-Form Tests: Patterns in Stock
    Returns
    Returns over short horizons
    – Very short time horizons small magnitude of
    positive trends
    – 3-12 month some evidence of positive
    momentum
    Returns over long horizons – pronounced
    negative correlation
    Evidence on Reversals

    8-17
    Predictors of Broad Market Returns

    Fama and French


    – Aggregate returns are higher with higher
    dividend ratios
    Campbell and Shiller
    – Earnings yield can predict market returns
    Keim and Stambaugh
    – Bond spreads can predict market returns

    8-18
    Semi-Strong Tests: Market Anomalies

    P/E Effect
    Small Firm Effect (January Effect)
    – Invest in low-capitalization stocks
    – Earn excess returns

    8-19
    Figure 8.3 Returns in Excess of Risk-
    Free Rate and in Excess of the SML

    8-20
    Semi-Strong Tests: Market Anomalies
    (Con’t)
    Neglected Firm
    – Small firms tend to be neglected by large
    institutional traders
    Book-to-Market Ratios
    – Beta seems to have no power to explain
    average security returns

    8-21
    Figure 8.4 Average Annual Return
    as a Function of Book-to-Market

    8-22
    Semi-Strong Tests: Market Anomalies
    (Con’t)

    Post-Earnings Announcement Drift


    – There is a large abnormal return on the
    earnings announcement day

    8-23
    Figure 8.5 Cumulative Abnormal Returns in
    Response to Earnings Announcements

    8-24
    Strong-Form Tests: Inside Information

    The ability of insiders to trade profitability


    in their own stock has been documented in
    studies by Jaffe, Seyhun, Givoly, and
    Palmon
    SEC requires all insiders to register their
    trading activity

    8-25
    Interpreting the Evidence

    Risk Premiums or market inefficiencies—


    disagreement here
    – Fama and French argue that these effects can
    be explained as manifestations of risk stocks
    with higher betas
    – Lakonishok, Shleifer, and Vishney argue that
    these effects are evidence of inefficient
    markets

    8-26
    Figure 8.6 Return to Style Portfolio as a
    Predictor of GDP Growth

    8-27
    Interpreting the Evidence (Con’t)

    Anomalies or Data Mining


    – Rerun the computer database of past returns
    over and over and examine stock returns
    along enough dimensions:
    Simple chance may cause some criteria to appear
    to predict returns

    8-28
    8.4 MUTUAL FUND AND ANALYST
    PERFORMANCE

    8-29
    Stock Market Analysts

    Do analysts add value—mixed evidence


    – Womack study found that positive changes
    are associated with increased stock prices of
    about 5%
    – Negative changes result in average price
    decreases of 11%
    – Are prices change due to analysts’ information
    or through pressure brought on by the
    recommendations themselves

    8-30
    Mutual Fund Managers

    Some evidence of persistent positive and


    negative performance
    Potential measurement error for
    benchmark returns
    – Style changes
    – May be risk premiums
    Superstar phenomenon

    8-31
    Figure 8.7 Estimates of Individual
    Mutual Fund Alphas

    8-32
    Table 8.1 Performance of Mutual Funds
    Based on Three-Index Model

    8-33
    Figure 8.8 Persistence of
    Mutual Fund Performance

    8-34
    Table 8.2 Two-Way Table of Managers Classified
    by Risk-Adjusted Returns over Successive
    Intervals

    8-35

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