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Chap 011

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41 views28 pages

Chap 011

Uploaded by

Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 11 The Efficient

Market
Hypothesis

Investments, 8th edition


Bodie, Kane and Marcus

Slides by Susan Hine

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Efficient Market Hypothesis (EMH)

• Do security prices reflect information ?


• Why look at market efficiency?
– Implications for business and corporate
finance
– Implications for investment

11-2
Figure 11.1 Cumulative Abnormal
Returns Before Takeover Attempts:
Target Companies

11-3
Figure 11.2 Stock Price Reaction to
CNBC Reports

11-4
EMH and Competition

• Stock prices fully and accurately reflect


publicly available information
• Once information becomes available,
market participants analyze it
• Competition assures prices reflect
information

11-5
Versions of the EMH

• Weak
• Semi-strong
• Strong

11-6
Types of Stock Analysis

• Technical Analysis - using prices and volume


information to predict future prices
– Weak form efficiency & technical analysis
• Fundamental Analysis - using economic and
accounting information to predict stock prices
– Semi strong form efficiency & fundamental
analysis

11-7
Active or Passive Management

• Active Management
– Security analysis
– Timing
• Passive Management
– Buy and Hold
– Index Funds

11-8
Market Efficiency & Portfolio
Management
Even if the market is efficient a role exists for
portfolio management:
• Appropriate risk level
• Tax considerations
• Other considerations

11-9
Event Studies

• Empirical financial research that enables an


observer to assess the impact of a particular
event on a firm’s stock price
• Abnormal return due to the event is estimated
as the difference between the stock’s actual
return and a proxy for the stock’s return in the
absence of the event

11-10
How Tests Are Structured
• Returns are adjusted to determine if they are
abnormal
Market Model approach
a. rt = at + brmt + et
(Expected Return)
b. Excess Return =
(Actual - Expected)
et = rt - (a + brMt)

11-11
Are Markets Efficient

• Magnitude Issue
• Selection Bias Issue
• Lucky Event Issue

11-12
Weak-Form Tests

• Returns over the Short Horizon


– Momentum
• Returns over Long Horizons

11-13
Predictors of Broad Market Returns

• Fama and French


– Aggregate returns are higher with higher
dividend ratios
• Campbell and Shiller
– Earnings yield can predict market returns
• Keim and Stambaugh
– Bond spreads can predict market returns

11-14
Semistrong Tests: Anomalies

• P/E Effect
• Small Firm Effect (January Effect)
• Neglected Firm Effect and Liquidity Effects
• Book-to-Market Ratios
• Post-Earnings Announcement Price Drift

11-15
Figure 11.3 Average Annual Return for
10 Size-Based Portfolios, 1926 – 2006

11-16
Figure 11.4 Average Return as a
Function of Book-To-Market Ratio,
1926–2006

11-17
Figure 11.5 Cumulative Abnormal
Returns in Response to Earnings
Announcements

11-18
Strong-Form Tests: Inside Information
• The ability of insiders to trade profitability in
their own stock has been documented in
studies by Jaffe, Seyhun, Givoly, and Palmon
• SEC requires all insiders to register their
trading activity

11-19
Interpreting the Evidence

• Risk Premiums or market inefficiencies—


disagreement here
– Fama and French argue that these effects
can be explained as manifestations of risk
stocks with higher betas
– Lakonishok, Shleifer, and Vishney argue
that these effects are evidence of
inefficient markets

11-20
Figure 11.6 Returns to Style Portfolio as
a Predictor of GDP Growth

11-21
Interpreting the Evidence Continued

• Anomalies or Data Mining


• The noisy market hypothesis
• Fundamental indexing

11-22
Stock Market Analysts

• Do Analysts Add Value


– Mixed evidence
– Ambiguity in results

11-23
Mutual Fund Performance

• Some evidence of persistent positive and


negative performance
• Potential measurement error for benchmark
returns
– Style changes
– May be risk premiums
• Hot hands phenomenon

11-24
Figure 11.7 Estimates of Individual
Mutual Fund Alphas, 1972 - 1991

11-25
Table 11.1 Performance of Mutual Funds
Based on Three-Index Model

11-26
Figure 11.8 Persistence of Mutual Fund
Performance

11-27
Table 11.2 Two-Way Table of Managers
Classified by Risk-Adjusted Returns over
Successive Intervals

11-28

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