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Market Efficiency: Kevin C.H. Chiang

The document discusses market efficiency and the efficient market hypothesis. It defines an efficient market as one where security prices instantly reflect all available information. There are three forms of market efficiency - weak, semi-strong, and strong - based on what information is reflected in prices. For a market to be efficient, it requires many independent investors analyzing information randomly and rapidly adjusting prices. Testing involves seeing if known strategies produce abnormal risk-adjusted returns after costs. An efficient market implies things like technical analysis are useless and fundamental analysts cannot consistently outperform.

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Muntazir Hussain
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45 views11 pages

Market Efficiency: Kevin C.H. Chiang

The document discusses market efficiency and the efficient market hypothesis. It defines an efficient market as one where security prices instantly reflect all available information. There are three forms of market efficiency - weak, semi-strong, and strong - based on what information is reflected in prices. For a market to be efficient, it requires many independent investors analyzing information randomly and rapidly adjusting prices. Testing involves seeing if known strategies produce abnormal risk-adjusted returns after costs. An efficient market implies things like technical analysis are useless and fundamental analysts cannot consistently outperform.

Uploaded by

Muntazir Hussain
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Market efficiency

Kevin C.H. Chiang


Efficient market

 (Informationally) efficient market: a market in


which security prices adjust fully and rapidly
to the arrival of new information and,
therefore, the current prices of securities fully
reflect all available information about the
security.
3 sufficient conditions for an efficient
market (Fama)

 A large number of competing profit-


maximizing participants analyze and value
securities, each “independent” of the others.
 New information comes in a “random”
fashion.
 The competing investors attempt to adjust
security prices rapidly to reflect the effect of
new information.
3 forms of market efficiency, I

 Weak form: prices reflect all information


contained in the history of past trading.
Question: do past returns and prices predict
future returns?
3 forms of market efficiency, II

 Semi-strong form: prices reflect all publicly


available information (earnings, dividends,
PE ratios, book-to-market ratios, political
news, etc.)
Question: how quickly do prices reflect all
public information?
3 forms of market efficiency, III

 Strong form: prices reflect all relevant


information, including inside information.
Question: Do insiders make abnormal
returns?
Testing

 Does a known strategy produce consistently


abnormal returns after adjusting for
investment risk and transaction costs?
 No: the market is quite efficient.
 Yes: evidence against the EMH.
Implications, I

 In an efficient market, technical analysis is


useless.
 In a semi-strong form efficient market,
fundamental analysts (country analysts,
industry analysts, and company analysts), on
average, will not outperform the market.
Implications, II

 In a semi-strong form efficient market,


fundamental analysis is useless.
 In this market, a portfolio manager should:
(1) determine a proper level of risk tolerance,
(2) form a portfolio consisting of the risk-free
asset and a well-diversified risky portfolio
(passive management), and (3) minimize
taxes and total transaction costs.
Passive management

 No attempt to find undervalued securities.


 No attempt to time.
 Hold a well-diversified portfolio.
Active management/selection

 Believe that one can beat the market.


 Find undervalued securities.
 Time the market.

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