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Market Efficiency: Finance week 09

# Market Efficiency: Finance week 09

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05/09/2014

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IPCOR421 Finance
Alex Kane
1
CLASS NOTES
WEEK IX
MARKET EFFICIENCY
IPCOR421 Finance
Alex Kane
2
How we think of time-series processes
\u2022The value of any RV (random variable) in a time series,
here price of a security, P(t), can be represented by:
P(t+1) = E(P) + e(t+1),
where E(P) is the expectation at time t for the price
at time t+1, and e(t+1) is a (zero-mean) surprise

\u2022This useful decomposition is just a tautology -- it is true by definition of expectation, E(P), and tells us nothing about the process of prices

\u2022In analyzing time series we ask: What do we know
IPCOR421 Finance
Alex Kane
3
Two alternative time series
\u2022Consider two alternative time series of daily prices

2. P(t+1) = P* + e(t+1),
where E(P)=P* is a known value that doesn\u2019t
change from day to day

3. P(t+1) = P(t) + e(t+1).
Here, E(P)=P(t) is changing daily. The
expectation for the next-day price is today\u2019s
price (this is called a random walk)