Professional Documents
Culture Documents
Chapter 12
Efficient Market Hypothesis (EMH)
• Are security markets efficient relative to the
information available for valuing securities?
• Do security prices reflect relevant information
quickly and accurately?
• Why look at market efficiency?
– Implications for business and corporate finance
– Implications for investment
8-2
Random Walk and the EMH
8-3
Random Walk with Positive Trend
Security
Prices
Time
8-4
Market Efficiency
8-5
What Does “Beat the Market” Mean?
8-6
Forms of Market Efficiency,
(i.e., What Information is Used?)
8-7
Why Would a Market be Efficient?
8-8
Random Price Changes
8-9
EMH and Competition
8-10
Types of Stock Analysis
• Technical Analysis - using prices and
volume information to predict future
prices.
– If securities markets are weak form efficient,
then technical analysis is useless
• Fundamental Analysis - using economic
and accounting information to predict
stock prices.
– If securities markets are semi strong form
efficient, then fundamental analysis is
useless
8-11
Technical Analysis
8-12
Dow Theory, I.
8-13
Dow Theory, II.
10,000
Level
9,000
Secondary
trends,
temporary Corrections,
8,000 departures reversions to the
primary direction
7,000
01/01 04/01 07/01 10/01 01/02 04/02 07/02 10/02 01/03 04/03 07/03 10/03
Date
8-14
Dow Theory, III.
8-15
Support and Resistance Levels
8-17
Technical Indicators, Notes
8-18
Charting, Relative Strength
8-19
Charting, Moving Averages
8-20
Example: 15-Day and
50-Day Moving Averages
Dow Jones Industrial Average,
15-Day and 50-Day Moving Average
11,000
10,500
10,000
15-Day 50-Day
Index Level
9,500
9,000
8,500
8,000
7,500
1/2/02 3/6/02 5/7/02 7/9/02 9/9/02 11/7/02 1/10/03 3/14/03 5/15/03 7/17/03 9/17/03
Date
8-21
More Chart Types
8-22
Candlestick Making, Basics
8-23
Candlestick “Formations”
8-24
Point and Figure Charts, I.
• Point-and-figure charts attempt to show only major price
moves and their direction.
– The point and figure chart maker decides what price move is
major.
– That is, it could be $2, $5, or any other level.
8-26
Point and Figure Charts, III.
8-27
Chart Formations
8-28
Chart Formations, The Head and Shoulders
8-29
Other Technical Indicators
8-30
Are Financial Markets Efficient?
8-32
Active or Passive Management
• Active Management
– Security analysis
– Timing
• Passive Management
– Buy and Hold
– Index Funds
8-33
Market Efficiency & Portfolio Management
8-34
Empirical Tests of Market Efficiency
• Event studies
• Assessing performance of professional
managers
• Testing some trading rule
8-35
Event Studies: How Tests Are Structured
8-36
Returns Over Time
-t 0 +t
Announcement Date
8-37
How Tests Are Structured (cont’d)
8-38
How Tests Are Structured (cont’d)
-t 0 +t
8-39
Issues in Examining the Results
• Magnitude Issue
– Someone researching for a large fund only
needs a small gain to justify the research –
too small too measure, relative to noise
• Selection Bias Issue
– Those who know how to beat the market
keep it a secret (or else everyone would do it;
thus, we don’t know how to study those who
beat the market
8-40
Issues in Examining the Results
8-42
What Does the Evidence Show?
• Fundamental Analysis
– Broad market returns seem to be influenced
by dividend yields, earnings yields, bond yield
spreads. These may simply be proxies for
changing betas.
– Many event studies reinforce semi strong
market efficiency such as Figure 12.1
8-43
What Does the Evidence Show?
• Anomalies Exist
– Anomalies are empirical results that are
known, but should not exist in an efficient
market. Is that beta is an incomplete or even
wrong measure of risk, or are markets not
efficient?
– For example, Basu found a P/E effect, after
adjusting for Beta. Is there a P/E effect, or is
P/E just a measure of the firm risk, that adjust
quickly, while a beta measurement is based
on long term data?
8-44
Stock Price Behavior and Market Efficiency
8-45
The Amazing January Effect, I.
8-46
The Amazing January Effect, II.
8-47
The Market Crash in October 1987
8-48
The Performance of
Professional Money Managers
• From 1963 to 1998, the S&P 500 index outperformed
general equity mutual funds 22 times (out of 36).
• Why can’t the pros beat the averages? (You can hold a
market average very easily—SPDRs)
8-49
Other Anomalies
• Neglected Firm
– Neglected firms are typically small firms for which
there is little analyst coverage. Tend to have higher
returns – may be due to lack of liquidity. Suggests
this a risk premium in addition to beta
• Market to Book Ratios
– market to book ratios seem to explain returns better
than beta
• Post-Earnings Announcement Drift
– ( see Figure 12.7). The reaction to earnings
announcement continues after the announcement
date.
8-50
Strong Form Efficiency Tests
8-51
Explanations of Anomalies
8-52
Information Processing
8-53
Behavioral Biases
8-56
So, are markets efficient?
8-57