Chapter 8: Efficient Market Hypothesis Fin 371
magnitude issue, selection bias issue, lucky even tissue
3 issues in debate on how efficient markets are
price patterns
________ ________ are self destructing because people immediately exploit them and then drive the stock to its fair price
inefficiency
active management assumes __________ in the market
fundamental analysis
active management uses what to pick securities
people who have huge portfolios because small % increases in returns don't add up to much for smaller portfolios
active portfolio management is really only useful for what types of people
active
backers of emh think _____________ portfolio management is dumb
technical analysis
believes information regarding future economic prospects of the firm is not necessary successful trading strategy
passive investment strategies
buying a well diversified portfolio w/o attempting to search out misplaced securities
rational security selection
calls for selective a well-diversified portoflio providing the systematic risk that the customer wants
prices of stocks reflect all available information
every version of EMH asserts what
measure serial correlation in stock returns
example of test of weak form market hypothesis
overreact to relevant news>reverse extreme investment performance after overreaction is recognized
explain how reversal effect works
old investors probably want to avoid fluctuation long terms bonds younger investors may like long term bonds because of steady flow of interest
explain how risk profile of investors is an argument for rational portfolio management
people or companies occasionally just get super lucky and get above average returns
explain lucky event issue
managers may increase returns by a bit ,but the stock market also naturally fluctuates every year. hard to measure contribution of manager
explain magnitude issue
information we have on attempts to predict the market are preselected in favor of failed attempts because no one who could actually predict the marekt would share their secrets
explain selection bias issue
strong form
form of efficient market hypothesis asserts that stock prices reflect all relevant information, including inside information
semi-strong form
form of efficient market hypothesis that asserts that stock prices already reflect all publicly available information
index fund
fund designed to replicate performance of broadbased index of stocks ex-holding portfolio of stocks in direct proportion to the weight in S&P 500
efficient market hypothesis
fundamental analysis goes against
obtain and exploit insight about future performance of firm that is not recognized by rest of market-finds firms that are better than what everyone else thinks
goal of fundamental analysis
overreact to new information>bigger or lower returns than necessary>correction of overreaction leads to reversal of performance (like really good to kind of bad)
how are fad hypothesis and negative correlated stock returns related
people profit from insider training
how do we know that our markets are not strong form
fad hypothesis
hypothesis that asserts that stock market may overreact to relevant news
efficient market hypothesis
hypothesis that prices of securities fully reflect information available about securities
active strategies should outperform passive strategies
if markets are not efficient, what does this mean for active and passive strategies
conduct their own research to validate prices
if markets are not informationally efficient, investors should do what
passive management
index funds are associated with active or passive management
investment returns
investors have an incentive to spend time and money to analyze and uncover new information only if it will likely result in higher ___________ ____________
identify trends that can be exploited while stock prices react slowly to new information
key to being successful in technical analysis
active seeks out mispriced securities-passive doesn't
main difference between active and passive strategies
random walk
notion that stock changes are unpredictable and random
semi-strong form
our markets are what form of EMH
buy and hold
passive investment strategy is characterized by a ________ _____ ________ strategy
semi-strong form
passive management is consistent with what form of market efficiency
anomalies
patterns of return that seem to contradict the EMH
resistance levels
price level above which it is unlikely for a stock to rise
support level
price level below which it is unlikely for a stock to fall
current information
random walk is result of prices that reflect all ___________ ___________
technical analysis
research on recurrent and predictable stock price patterns and on proxies for buying or selling pressure in the market
fundamental analysis
research on the determinants of stock value, such as earnings and dividend prospects, expectations for future interest rates, and risk of the firm
ETFs
shares in diversified portfolios that are bought and sold like shares of individual stocks
mutual funds, etfs, economies of scale
small investors are better off investing in ________________ or _____________ because you can pool money from others and gain from _________________
random walk
stock prices follow _____________ ___________
new information
stock prices increase or decrease as a result of ____________ ____________
value
stock trends lose __________ as they become well known
false
technical analysis implies that efficient market hypothesis is
chartists
technical analysts are also called _________ because they study charts or past stock prices to find patterns that they can exploit for profits
reversal effect
tendency of poorly performance stocks and well performing stocks in one period to experience reversals in the following period
momentum effect
tendency of poorly performing stocks and well performing stocks in one period to continue that abnormal performance in following periods
serious analysis, uncommon techniques
these two things generate differential insight necessary to yield profits from stock analysis
false
true/false markets are expected to be strong form efficient
true
true/false the degree of efficiency varies across various markets
false (be correct on average)
true/false using current info, we can be sure that stock prices are too high or too low every day
resistance levels, support levels
two components of technical analysis
weak form
version of efficient market hypothesis that asserts that stock prices already reflect all information contained in the history of past trading
trend analysis because if there were any reliable stock trends, people would exploit them to make money
weak form efficient market hypothesis implies what is useless
find npv of all payments that stockholder will receive from each share if value > npv, buy the stock
what does fundamental analysis try to do
trying to discern trends in stock prices to make money
what is a test of weak form market hypothesis
tailor portfolio to needs of investors (age, tax bracket, rick tolerance, etc.) rather than try to beat the market
what is the role of portfolio managers assuming there is an efficient market
recent losers, avoid recent winners
what you should you invest in according to reversal effect
immediately
when are prices changed to their fair level after new information is released according to EMH
weak form market
when can fundamental analysis be used to predict stock changes
indicates that all available information is not reflected in stock prices
why are predictable stock prices evidence of an inefficient market
new price pattern is discovered>everyone uses it at once>becomes useless
why are price patterns self destructing
because there is a lot of competition to find new information
why do stock prices reflect available information regarding their levels
trend analysis uses past trends everyone can look at these trends>try to exploit them all at once>immediately drive price to fair level
why does efficient market hypothesis think technical analysis is impossible
because everyone has access to publicly available information, so your analysis isn't likely to be more profound than anyone else's. need unique insight to make money
why does fundamental analysis contradict EMH
because it believes that stock prices react slowly to fundamental supply and demand factors
why does technical analysis go against the idea of efficient markets
because new information is unpredictable, and stock prices react to new information
why is it assumed that stock prices follow random walk
not paying anyone to assess stocks or incur a bunch of transaction costs
why is passive management cheaper than active management
