Professional Documents
Culture Documents
C06
C06
Are Financial
Markets Efficient?
Rof = R*
This equation tells us that current prices in a financial
market will be set so that the optimal forecast of a
security’s return using all available information equals
the security’s equilibrium return.
As a result, a security’s price fully reflects all available
information in an efficient market.
Note, R* depends on risk, liquidity, other asset returns
…
Overview
─ Reasonable starting point but not whole story
Cost Compare
Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-35
© 2012 Pearson Prentice Hall. All rights reserved. 6-35
Case: Any Efficient Markets Lessons from Black
Monday of 1987 and the Tech Crash of 2000?
Overconfidence
─ People set overly narrow confidence bands, high
guess is too low and low guess is too high.
─ Results in being surprised too often.
Hedonic editing
─ Organizing Gains and Losses in separate mental
accounts.
• One loss and one gain are netted against each other.
• Two gains are savored separately
• But multiple losses are difficult to net out against moderate
gains.