Chapter 3 Market Efficiency
description
Transcript of Chapter 3 Market Efficiency
![Page 1: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/1.jpg)
CHAPTER 3 MARKET EFFICIENCY
PresenterVenueDate
![Page 2: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/2.jpg)
DEFINITION OF AN EFFICIENT MARKET
Past information
Public information
Private information
![Page 3: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/3.jpg)
FACTORS AFFECTING MARKET EFFICIENCY
Time frame of price adjustments
Transaction costs and information-acquisition costs
Other factorsMarket value
versus intrinsic value
Market efficiency
![Page 4: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/4.jpg)
ACTIVE VERSUS PASSIVE INVESTMENT STRATEGIES
Market efficiency
Active investment strategies
![Page 5: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/5.jpg)
FACTORS AFFECTING A MARKET’S EFFICIENCY
A market should be viewed as falling on a continuum between two extremes:
Completely Inefficient
CompletelyEfficient
Continuum
Large Cap Stocks
![Page 6: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/6.jpg)
FORMS OF MARKET EFFICIENCY (FAMA 1970)
Market prices reflect:
Forms of market efficiencyPast market
dataPublic
informationPrivate
informationWeak form of market efficiency Semi-strong form of market efficiency
Strong form of market efficiency
![Page 7: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/7.jpg)
WEAK FORM OF MARKET EFFICIENCY
Serial correlation in security
returns
Usefulness of technical
analysis
Tests of weak form
market efficiency
![Page 8: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/8.jpg)
SEMISTRONG FORM OF MARKET EFFICIENCY
Prices reflect public
information
Fundamental analysis
![Page 9: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/9.jpg)
THE EVENT STUDY PROCESS
![Page 10: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/10.jpg)
STRONG FORM OF MARKET EFFICIENCY
Past informatio
n
Public informatio
n
Private informatio
nPrice
![Page 11: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/11.jpg)
WHAT FORM OF MARKET EFFICIENCY EXISTS?
Nonpublic information
Abnormal profits
![Page 12: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/12.jpg)
QUESTIONS1) Is the expected return for stocks equal to zero in
an efficient market?2) Which hypothesis is being tested if a researcher
examines stock price performance following earnings announcements?
3) Which hypothesis is being tested if a researcher examines stock price performance based on a 50-day and 200-day moving average of prices?
4) Why might a stock’s price not reflect everything management knows about their company?
![Page 13: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/13.jpg)
WHAT GOOD IS FUNDAMENTAL ANALYSIS?
Fundamental analysis
Value-relevant information
Possible abnormal returns
![Page 14: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/14.jpg)
WHAT GOOD IS TECHNICAL ANALYSIS?
Usefulness of past data Prevalence of
technical analysis
![Page 15: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/15.jpg)
WHAT GOOD ARE PORTFOLIO MANAGERS?
“Beat the market”
Manage portfolio
objectives
![Page 16: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/16.jpg)
MARKET PRICING ANOMALIES
Market efficiency
Existence of market pricing
anomalies
![Page 17: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/17.jpg)
Time series Cross-sectional Other January effect Size effect Closed-end fund discount Day-of-the-week effect Value effect Earnings surprise Weekend effect Book-to-market ratios Initial public offerings Turn-of-the-month effect P/E ratio effect Distressed securities effect Holiday effect Value Line enigma Stock splits Time-of-day effect Super Bowl Momentum Overreaction
EXHIBIT 3-3 SAMPLING OF OBSERVED PRICING ANOMALIES
![Page 18: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/18.jpg)
JANUARY (TURN-OF-THE-YEAR) EFFECT
January effect
Window dressing
Tax loss selling
Other explanation
s
![Page 19: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/19.jpg)
EXHIBIT 3-4 OTHER CALENDAR-BASED ANOMALIES
Anomaly Observation Turn-of-the-month effect
Returns tend to be higher on the last trading day of the month and the first three trading days of the next month.
Day-of-the-week effect The average Monday return is negative and lower than the average returns for the other four days, which are all positive.
Weekend effect Returns on weekends tend to be lower than returns on weekdays. Holiday effect Returns on stocks in the day prior to market holidays tend to be
higher than other days.
![Page 20: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/20.jpg)
OVERREACTION AND MOMENTUM ANOMALIES
• Stock prices become inflated (depressed) for those companies releasing good (bad) news.
Overreaction anomaly
• Securities that have experienced high returns in the short term tend to continue to generate higher returns in subsequent periods.
Momentum anomaly
![Page 21: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/21.jpg)
CROSS-SECTIONAL ANOMALIES
Small cap outperforms large cap
Value outperforms growth
![Page 22: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/22.jpg)
CLOSED-END INVESTMENT FUNDS
NAV DiscountValue of closed-
end fund
![Page 23: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/23.jpg)
EARNINGS SURPRISE
Beginning price
Positive earnings surprise
Price rises
Negative earnings surprise
Price fallsEnding price
![Page 24: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/24.jpg)
INITIAL PUBLIC OFFERINGS (IPOS)
Offering price
Abnormal profits
Closing price
![Page 25: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/25.jpg)
“FRONTIERS OF FINANCE SURVEY”THE ECONOMIST (9 OCTOBER 1993)
Many (anomalies) can be explained away. When transactions costs are taken into account, the fact that stock prices tend to over-react to news, falling back the day after good news and bouncing up the day after bad news, proves unexploitable: price reversals are always within the bid-ask spread. Others such as the small-firm effect, work for a few years and then fail for a few years. Others prove to be merely proxies for the reward for risk taking. Many have disappeared since (and because) attention has been drawn to them.
![Page 26: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/26.jpg)
BEHAVIORAL FINANCE VERSUS TRADITIONAL FINANCE
Behavioral FinanceAssumes:• Investors suffer from
cognitive biases that may lead to irrational decision making.
• Investors may overreact or under-react to new information.
Traditional FinanceAssumes:• Investors behave
rationally.• Investors process new
information quickly and correctly.
![Page 27: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/27.jpg)
LOSS AVERSION
Like gains
Dislike losses
![Page 28: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/28.jpg)
OVERCONFIDENCE
New information
Investor overconfidence
Mispriced securities
![Page 29: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/29.jpg)
OTHER BEHAVIORAL BIASES
Representativeness
Gambler’s fallacy
Mental accounting
Conservatism
Disposition effect
Narrow framing
![Page 30: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/30.jpg)
INFORMATION CASCADES
Release of information1 Informed
traders trade2Uninformed
traders imitate informed traders
3
![Page 31: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/31.jpg)
IF INVESTORS SUFFER FROM COGNITIVE BIASES, MUST MARKETS BE INEFFICIENT?
Theory suggests “Yes!”If investors must be rational for efficient markets to exist, then all the foibles of human investors suggest that markets cannot be efficient.
Evidence suggests “No!”If all that is required for markets to be efficient is that investors cannot consistently beat the market on a risk-adjusted basis, then the evidence supports market efficiency.
![Page 32: Chapter 3 Market Efficiency](https://reader036.fdocuments.in/reader036/viewer/2022081421/56815d4a550346895dcb5190/html5/thumbnails/32.jpg)
SUMMARY
• Definition of efficient markets• Different forms of market efficiency• Evidence regarding market efficiency• Implications for fundamental analysis, technical analysis, and portfolio management
• Market pricing anomalies• Behavioral finance