1 Bodie Kane Marcus Essentials of Investments Fourth
1 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Chapter 9 The Efficient Market Hypothesis Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
2 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Efficient Market Hypothesis (EMH) • Do security prices reflect information ? • Why look at market efficiency – Implications for business and corporate finance – Implications for investment Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
3 Essentials of Investments Bodie • Kane • Marcus Fourth Edition Random Walk and the EMH • Random Walk - stock prices are random – Actually submartingale • Expected price is positive over time • Positive trend and random about the trend Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
4 Bodie • Kane • Marcus Security Prices Essentials of Investments Fourth Edition Random Walk with Positive Trend Time Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
5 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Random Price Changes • Why are price changes random? – Prices react to information – Flow of information is random – Therefore, price changes are random Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
6 Essentials of Investments Bodie • Kane • Marcus Fourth Edition 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 Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
7 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Forms of the EMH • Weak • Semi-strong • Strong Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
8 Bodie • Kane • Marcus Essentials of Investments Fourth Edition 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 Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
9 Essentials of Investments Bodie • Kane • Marcus Fourth Edition Implications of Efficiency for Active or Passive Management • Active Management – Security analysis – Timing • Passive Management – Buy and Hold – Index Funds Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
10 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Market Efficiency and Portfolio Management Even if the market is efficient a role exists for portfolio management • Appropriate risk level • Tax considerations • Other considerations Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
11 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Empirical Tests of Market Efficiency • Event studies • Assessing performance of professional managers • Testing some trading rule Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
12 Bodie • Kane • Marcus Essentials of Investments Fourth Edition How Tests Are Structured 1. Examine prices and returns over time Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
Essentials of Investments Bodie • Kane • Marcus 13 Fourth Edition Returns Surrounding the Event -t 0 +t Announcement Date Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
14 Essentials of Investments Bodie • Kane • Marcus Fourth Edition How Tests Are Structured (cont. ) 2. Returns are adjusted to determine if they are abnormal Market Model approach a. Rt = at + bt. Rmt + et (Expected Return) b. Excess Return = (Actual - Expected) et = Actual - (at + bt. Rmt) Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
15 Essentials of Investments Bodie • Kane • Marcus Fourth Edition How Tests Are Structured (cont. ) 2. Returns are adjusted to determine if they are abnormal Market Model approach c. Cumulate the excess returns over time: -t Irwin / Mc. Graw-Hill 0 +t © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
16 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Issues in Examining the Results • • Magnitude Issue Selection Bias Issue Lucky Event Issue Possible Model Misspecification Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
17 Essentials of Investments Bodie • Kane • Marcus Fourth Edition What Does the Evidence Show? • Technical Analysis • Fundamental Analysis • Anomalies Exist Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
18 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Anomalies • • Small Firm Effect (January Effect) Neglected Firm Market to Book Ratios Reversals Value Line Enigma Post-Earnings Announcement Drift Higher Level Correlation in Security Prices Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
19 Essentials of Investments Bodie • Kane • Marcus Fourth Edition Mutual Fund and Professional Manager Performance • Some evidence of persistent positive and negative performance • Potential measurement error for benchmark returns – Style changes – May be risk premiums • Superstar phenomenon Irwin / Mc. Graw-Hill © 2001 The Mc. Graw-Hill Companies, Inc. All rights reserved.
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