Chapter 11: The Efficient Market Hypothesis

Index fund

A mutual fund holding shares in proportion to their representation in a market index such as the S&P 500.

Weak-form EMH

Asserts that stock prices already reflect all information contained in the history of past prices.

Semistrong-form EMH

Asserts that stock prices already reflect all publicly available information.

Strong-form EMH

Asserts that stock prices reflect all relevant information including insider information.

Passive investment strategy

Buying a well-diversified portfolio to represents broad-based market index without attempting to search out mispriced securities.

Random walk

Describes the notion that stock price changes are random and unpredictable.

Resistance levels

A price level above which it is supposedly difficult for a stock or stock index to rise.

Support levels

A price level below which it is supposedly difficult for a stock or stock index to fall.

Abnormal return

Return on a stock beyond what would be predicted by market movements alone. Cumulative abnormal return (CAR) is the total abnormal return for the period surrounding an announcement or the release of information.

Small-firm effect

That investments in stocks of small firms appear to have earned abnormal returns.

Anomolies

Patterns of returns that seem to contradict the efficient market hypothesis.

Neglected-firm effect

That investments in stock of less well-known firms have generated abnormal returns.

P/E effect

That portfolios of low P./E stocks have exhibited higher average risk-adjusted returns than high P/E stocks.

Cumulative abnormal return (CAR)

The total abnormal return for the period surrounding an announcement or the release of information.

Event study

Research methodology designed to measure the impact of an event of interest on stock returns.

Technical analysis

Research to identify mispriced securities that focuses on recurrent and predictable stock price patterns and on proxies for buy or sell pressures in the market.

Fundamental analysis

Research to predict stock value that focuses on such determinants as earnings and dividends prospects, expectations for future interest rates, and risk evaluation of the firm.

Efficient market hypothesis

The prices of securities fully reflect available information. Investors buying securities in an efficient market should expect to obtain an equilibrium rate of return. Weak-form EMH asserts that stock prices already reflect all information contained in the history of past prices. The semistrong-form hypothesis asserts that stock prices already reflect all publicly available information. The strong-form hypothesis asserts that stock prices reflect all relevant information including insider information.

Book-to-market effect

The tendency for stocks of firms with high ratios of book-to-market value to generate abnormal returns.

Momentum effect

The tendency of poorly performing stocks and well-performing stocks in one period to continue that abnormal performance in following periods.

Reversal effect

The tendency of poorly performing stocks and well-performing stocks in one period to experience reversals in following periods.