Efficient Market Hypothesis and Behavior Finance

Trin Statistic

(Volume Declining/number declining)/ (Volume advancing / number advancing)

Breadth

A measure of the extent to which movement in a market index is reflected widely in the price movements of all the stocks in the market

Mental Accounting

A specific form of framing in which people segregate certain decisions.

Book-to-market effect

After controlling for the size and book-to-market effects, beta seemed to have no power to explain average security returns.

Semi-strong-form Efficient Market

All publicly available information regarding the prospects of a firm must be reflected already in the stock price. In addition to past prices, it conveys firm s balance sheet composition, management quality.

Regret Avoidance

Any losses on the blue-chip stocks can be more easily attributed to bad luck rather than bad decision making and cause less regret.

Framing

Decisions seem to be affected by how choices are framed.

Anomalies

Difficult to reconcile with the efficient market hypothesis

Index Fund

Fund designed to replicate the performance of a broad-based index of stocks

Momentum Effect

Good or bad recent performance of particular stocks continue over time

Conservatism Bias

Investors are too slow in updating their beliefs in response to new evidence. This means that they might initially under-react to news about a firm, so that prices will fully reflect new information only gradually.

Event Study

It describes a technique of empirical financial research that enables an observer to assess the impact of a particular event on a firm's stock price

Efficient Market Hypothesis

It is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. Stock always trade at fair value.

Relative Strength

It measures the extent to which a security has outperformed or underperformed either the market as a whole or its particular industry.

Fundamental Analysis

It uses earnings and dividends prospects of the firm, expectations of future interest rate, and risk evaluation of the firm to determine proper stock prices

Prospect Theory

Losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses. Also known as loss-aversion theory, the general concept is that if two choices are put before an individual, one presented with potential gains, and one with potential loss, the former option will be chosen.

P/E effect

Low P/E ratio stocks have provided higher return s than high P/E portfolios. It holds up even if returns are adjusted for portfolio beta.

Fundamental Risk

Markets can remain irrational longer than you can remain solvent. The fundamental risk incurred in exploiting apparent profit opportunities presumably will limit the activity of traders.

Representativeness Bias

People commonly do not take into account the size of a sample, acting as if a small sample is just as representative of a population as a large one.

Behavioral Finance

Premise: conventional financial theory ignores how real people make decisions and that people make a difference.

Random Walk

Price changes should be random and unpredictable

Passive Investment Strategy

Proponents of efficient market hypothesis believes that active management is largely wasted effort and unlikely to justify the expense incurred. Therefore, they advocate a passive investment strategy that makes no attempt to outsmart the market.

Neglected-firm effect

Small firms are neglected by traders, their information is less available. This information deficiency makes smaller firms riskier investments that command higher returns.g

Small-firm effect

Small-sized firms yield higher annual return, because they are riskier. Even adjust the risk using CAMP, they still yield a consistent premium

Weak-form Efficient Market Hypothesis

Stock prices already reflect all information that can be derived by examining market trading data such as the history of past prices, trading volume or short interest. It implies that trend analysis is fruitless because the past data are publicly available.

Disposition Effect

Tendency of investors to hold on to losing investments

Abnormal Return

The abnormal return due to the event is estimated as the difference between the stock's actual return and this benchmark.

Put/Call Ratio

The ratio of outstanding put options to outstanding call options

Technical Analysis

The search for recurrent and predictable patterns in stock prices.

Strong-form Efficient Market

The stock prices reflect all information relevant to the firm, even including information available only to company insiders.

Cumulative Abnormal Return (CAR)

The sum of all abnormal returns over the time period of interest. It captures the total firm-specific stock movement for an entire period when the market might be responding to new information.

Resistance Levels / Support levels

These values are said to be price levels above which it is difficult for stock prices to rise or below which it is unlikely for them to fall, and they are believed to be levels determined by market psychology.

Reversal Effect

losers rebound and winners fade back, suggests that the stock market overreacts to relevant news.

Confidence Index

the ratio of the average yield on 10 top-rated corporate bonds divided by the average yield on 10 intermediate-grade corporate bonds.