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Chapter 08 - The Efficient Market Hypothesis

The document discusses the efficient market hypothesis which states that stock prices reflect all available information. It provides several examples: - Stock prices already reflect any predictable information like future dividends, so that information does not make a stock more attractive to purchase. - The market cannot be beaten consistently because randomness means that about half of managers will outperform due to luck in any given year. Consistent outperformance indicates use of information not reflected in the price. - If past performance could predict future returns, that would provide an "easy money" rule to exploit, which violates efficiency. Prices instead move randomly. - The market quickly incorporates any new public information, so there is no benefit to trading after an

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34 views

Chapter 08 - The Efficient Market Hypothesis

The document discusses the efficient market hypothesis which states that stock prices reflect all available information. It provides several examples: - Stock prices already reflect any predictable information like future dividends, so that information does not make a stock more attractive to purchase. - The market cannot be beaten consistently because randomness means that about half of managers will outperform due to luck in any given year. Consistent outperformance indicates use of information not reflected in the price. - If past performance could predict future returns, that would provide an "easy money" rule to exploit, which violates efficiency. Prices instead move randomly. - The market quickly incorporates any new public information, so there is no benefit to trading after an

Uploaded by

williamnyx
Copyright
© © All Rights Reserved
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Chapter 08 - The Efficient Market Hypothesis

CHAPTER 08 THE EFFICIENT MARKET HYPOTHESIS


14. No, it is not more attractive as a possible purchase. Any value associated with dividend
predictability is already reflected in the stock price.
17
b. Consistent.Halfofallmanagersshouldoutperformthemarketbasedonpure
luckinanyyear.
c. Violation.Thiswouldbethebasisforan"easymoney"rule:simplyinvestwith
lastyear'sbestmanagers.
d. Consistent.Predictablevolatilitydoesnotconveyameanstoearnabnormal
returns.
e. Violation.TheabnormalperformanceoughttooccurinJanuary,whenthe
increasedearningsareannounced.
f. Violation.Reversalsofferameanstoearneasymoney:simplybuylastweek's
losers.
21 You should buy the stock. In your view, the firms management is not as bad as
everyone else believes it to be. Therefore, you view the firm as undervalued by the
market. You are less pessimistic about the firms prospects than the beliefs built into
the stock price.
22 The market may have anticipated even greater earnings. Compared to prior
expectations, the announcement was a disappointment.
CFA 1
b
Public information constitutes semi-string efficiency, while the addition of
private information leads to strong form efficiency.
CFA 2
a
The information should be absorbed instantly.
CFA 3
b
Since information is immediately included in stock prices, there is no benefit to
buying stock after an announcement.
CFA 4
c
Stocks producing abnormal excess returns will increase in price to eliminate the
positive alpha.
CFA 5
c
A random walk reflects no other information and is thus random.
CFA 6
d
Unexpected results are by definition an anomaly.
8-1

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