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    Emh 2

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    ba22samyuktha
    The document discusses the efficient market hypothesis (EMH) and its implications. Some key points: - EMH proposes that stock prices fully reflect all available public information, making it impossible for investors to earn above-average returns. Fundamental and technical analysis are useless according to EMH. - Three forms of market efficiency are defined based on the information reflected in prices: weak, semi-strong, and strong. Semi-strong efficiency suggests prices reflect all public information. - Event studies can test semi-strong efficiency by examining stock price reactions to new public information. Anomalies that contradict EMH predictions would challenge the theory's validity. While EMH remains influential, some anomalies have been observed.

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    © All Rights Reserved
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    Emh 2

    Uploaded by

    ba22samyuktha
    17 views50 pages
    The document discusses the efficient market hypothesis (EMH) and its implications. Some key points: - EMH proposes that stock prices fully reflect all available public information, making it impossible for investors to earn above-average returns. Fundamental and technical analysis are useless according to EMH. - Three forms of market efficiency are defined based on the information reflected in prices: weak, semi-strong, and strong. Semi-strong efficiency suggests prices reflect all public information. - Event studies can test semi-strong efficiency by examining stock price reactions to new public information. Anomalies that contradict EMH predictions would challenge the theory's validity. While EMH remains influential, some anomalies have been observed.

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    emh 2

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    The document discusses the efficient market hypothesis (EMH) and its implications. Some key points: - EMH proposes that stock prices fully reflect all available public information, making it impossible for investors to earn above-average returns. Fundamental and technical analysis are useless according to EMH. - Three forms of market efficiency are defined based on the information reflected in prices: weak, semi-strong, and strong. Semi-strong efficiency suggests prices reflect all public information. - Event studies can test semi-strong efficiency by examining stock price reactions to new public information. Anomalies that contradict EMH predictions would challenge the theory's validity. While EMH remains influential, some anomalies have been observed.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    17 views50 pages

    Emh 2

    Uploaded by

    ba22samyuktha
    The document discusses the efficient market hypothesis (EMH) and its implications. Some key points: - EMH proposes that stock prices fully reflect all available public information, making it impossible for investors to earn above-average returns. Fundamental and technical analysis are useless according to EMH. - Three forms of market efficiency are defined based on the information reflected in prices: weak, semi-strong, and strong. Semi-strong efficiency suggests prices reflect all public information. - Event studies can test semi-strong efficiency by examining stock price reactions to new public information. Anomalies that contradict EMH predictions would challenge the theory's validity. While EMH remains influential, some anomalies have been observed.

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    of 50

    Market Efficiency

    Dr. Madhuri Malhotra


    A Startling Discovery: Random
    Price Changes
    • The concept of efficient capital markets stemmed from a chance
    discovery. In 1953, Maurice Kendall, a British statistician, presented a
    controversial paper to the Royal Statistical Society on the behavior of
    stock and commodity prices. 2

    • Kendall had expected to find regular price cycles, but to his surprise
    they did not seem to exist.
    • Each series appeared to be “a ‘wandering’ one.
    • The prices of stocks and commodities seemed to follow a random
    walk.
    price changes are
    independent of one
    another just as the
    gains and losses in the
    coin-tossing game are
    independent.
    Random walk
    • You should see now why prices in competitive markets must follow a
    random walk.
    • If past price changes could be used to predict future price changes,
    investors could make easy profits.
    • But in competitive markets, there are no such free lunches
    • As investors try to take advantage of any information in past prices,
    prices adjust immediately until the superior profits from studying price
    movements disappear. As a result, all the information in past prices
    will be reflected in today’s stock price, not tomorrow’s.
    • Patterns in prices will no longer exist, and price changes in one
    period will be independent of changes in the next. In other words, the
    share price will follow a random walk.
    Efficient market Hypothesis
    •A market in which stock prices fully reflect
    information is termed an efficient market. Economists
    define three levels of market efficiency, which are
    distinguished by the degree of information reflected in
    security prices.
    What Is the Efficient Market Hypothesis
    (EMH)

    share prices reflect all


    information.
    IS IT SO ??
    Efficient Market Hypothesis

    •PROPOUNDED BY – EUGENE, F. FAMA


    •STOCK PRICES REFLECT ALL AVAILABLE
    INFORMATION !!!
    •WHAT ABOUT INSIDER TRADING ?
    MAIN FINDINGS !!!

    • Fundamental Analysis Is Useless Since All the available information(book


    value , market value etc) are publicly available and its incorporated in the
    stock prices.

    • Technical analysis is useless as the past prices cannot be used to predict


    the future price of stock and the randomness
    Fundamental analysis
    • Fundamental analysis is a method of determining a stock's real or "fair
    market" value.
    • Fundamental analysts search for stocks currently trading at prices higher
    or lower than their real value.
    • If the fair market value is higher than the market price, the stock is
    deemed undervalued, and a buy recommendation is given.
    • If the fair market value is lower than the market price, the stock is
    deemed overvalued, and the recommendation might be not to buy or to
    sell if the stock is held.
    • In contrast, technical analysts favor studying the historical price trends of
    the stock to predict short-term future trends.
    Fundamental Analysis
    • Fundamental analysis is usually done from a macro to micro
    perspective to identify securities that are not correctly priced by the
    market.
    • Analysts typically study:
    1. The overall state of the economy
    2. The strength of the specific industry
    3. The financial performance of the company issuing the stock
    Intrinsic Value

    • the value reflected from the company's fundamental data is more


    likely to be closer to the true value of the stock.
    Fundamental analysis use

    • By focusing on a particular business, an investor can estimate the


    intrinsic value of a firm and find opportunities to buy at a discount
    or sell at a premium. The investment will pay off when the market
    catches up to the fundamentals.
    Efficient Market theory
    • EMH says over the long run stock prices reflect the true value.
    • Does this hold good ?
    Efficient Market theory
    “Security prices accurately reflect available information, and respond
    rapidly to new information as soon as it becomes available”
    ………………………………………………….Richard Brealey & Stewart Myers,
    Principles of Corporate Finance, 1996
    EMH

    • If new information becomes known about a particular company, how


    quickly do market participants find about the information? And buy and
    sell the securities of the company on the basis of the information ?
    Semi Strong Form Efficiency
    • Semi-strong efficiency
    • This form of EMH implies that all public information is calculated into a
    stock's current share price.
    • Neither technical nor fundamental analysis can be used to achieve
    superior gains.

    Friday, October 6, 2023


    How to estimate whether market is semi-strong
    form efficient?
    • Event Study

    Friday, October 6, 2023


    • Studies of the semi-strong form of the efficient markets
    hypothesis can be categorized as

    • Tests of the speed of adjustment of prices to new


    information. The principal research tool in this area is the
    event study.
    • An event study averages the cumulative performance of
    stocks over time, from a specified number of time periods
    before an event to a specified number of periods after.

    • Performance for each stock is measured after adjusting for


    market-wide movements in security prices.

    • The first event study was undertaken by Fama, Fisher, Jensen


    and Roll (1969), though the first to be published was by Ball
    and Brown (1968).

    Friday, October 6, 2023


    Overview of event Studies
    1. Event studies examine the effect of some
    event or set of events on the value of assets

    2.Unexpectedly large increase or decrease

    Friday, October 6, 2023


    An event can be:
    • What makes and event? - Some change, development,
    announcement that may produce a relatively large change in the
    price of the asset over some period.

    1. Stock splits
    2. Earning announcements
    3. Merger or takeover announcements
    4. Regulatory change
    5. any other announcement or event
    Friday, October 6, 2023
    Procedure
    • Define an event window – a period over which the event occurs
    • Define an estimation window – a period over which parameters are
    estimated

    Friday, October 6, 2023


    (T0...T1] is estimation window
    (T1...T2] is event window
    (T2...T3] is post-event window

    Friday, October 6, 2023


    How to estimate return due to event
    • Calculate Returns of the firms during the event
    window using the standard formula

    Today’s price – yesterday’s price


    _________________________________
    Yesterday’s price

    Friday, October 6, 2023


    • Estimate returns during the event window
    • Estimate market index returns

    • Return during the event window minus market index returns is


    abnormal returns .

    Friday, October 6, 2023


    Market adjusted Returns Method to estimate
    Abnormal Returns
    • ARit = Rit – Rmt

    ARit is the abnormal returns


    Rit is the firm’s returns
    Rmt is the market Index Returns

    • This method allows for general market movements, but assumes each
    firm has same average return and risk characteristics as market as a
    whole
    Friday, October 6, 2023
    Aggregation of Abnormal Returns
    Aggregate returns over time and across Firms
    Over time : aggregate across different time periods to see if effect
    develops over time
    Across firms : Aggregate across firms in the sample.

    Friday, October 6, 2023


    Aggregate over time

    CARi is Cumulative Abnormal Return for firm I Under the


    null hypothesis of no abnormal return, the abnormal return
    is zero.

    The term CAR(-5, 0) means the CAR calculated from five days
    before the announcement to the day of announcement.

    Friday, October 6, 2023


    CAPM and APT: what they say ?
    • These theories describe the structure of the prices of financial assets
    • Explain about the relationship between the return and the risk
    (beta)of a security.

    • Market efficiency theory focuses on “ How the market securities in


    relation to its structure”.
    Efficient Market Theory
    “Security prices accurately reflect available information, and respond
    rapidly to new information as soon as it becomes available”
    ………………………………………………….Richard Brealey & Stewart Myers,
    Principles of Corporate Finance, 1996
    EMH
    • If new information becomes known about a particular company, how
    quickly do market participants find about the information? And buy
    and sell the securities of the company on the basis of the information
    ?
    Forms of market efficiency !!!

    Strong Insider information / private


    information

    Public information
    Semi strong

    Past prices
    Weak
    EMH explained
    • https://www.youtube.com/watch?v=e-BoCacmkM8

    • https://www.youtube.com/watch?v=kJzfKuiBK50
    Implications of market efficiency

    • No group of investors should be able to consistently beat the market in an efficient


    market
    • Equity research and valuation would be a costly task that provided no benefits.
    • The stock price is equal to the fundamental or intrinsic value.
    • Financial assets cannot be overvalued and undervalued
    • They are always traded at their fair value
    Apprehensions regarding MARKET EFFICIENCY

    Anomalies !!!! What they


    are !!!
    What Is an Anomaly?

    • In economics and finance, an anomaly is when the actual result


    under a given set of assumptions is different from the expected
    result predicted by a model.
    • An anomaly provides evidence that a given assumption or model
    does not hold up in practice.
    ANOMALIES
    • Many authors such as Grossman and Stilgitz (1980) and Werner and
    Thaler (1985) market efficiency tests and identified certain
    anomalies----which led to many apprehensions regarding EMH.
    Financial market anomalies

    • Market anomalies are the usual occurrence or abnormality in smooth


    pattern of stock market.
    • They are cross sectional and time series patterns in stock returns that are
    not possible to be predicted by financial theories.
    • The term anomaly was put forth by Kuhn in 1970.
    Financial market anomalies
    • Financial market anomaly is a situation where in the performance of the
    stock deviate substantially from established assumptions and are not able to
    be explained by efficient market hypothesis.

    • These anomalies could earn large profits.


    Types of Anomalies

    • Fundamental anomalies
    • Technical Anomalies
    • Calendar Anomalies
    Value anomalies

    Fundamental anomalies
    Low price to book

    High dividend
    yield

    Low price to sales

    Low price to
    earnings
    Fundamental Anomalies
    •Value Anomalies: overestimation of future earnings of the
    growth companies and underestimation of future
    earnings of value company.
    •This anomaly stems from the feeling that stocks that have
    a low price to book ratio usually generate more returns
    than stocks having a high book to market ratio.
    High dividend yield
    • Stocks with high dividend yield have a tendency to outperform the
    market and generate better returns.
    Low price to sales
    • Price to sales ratio is an indicator of the value placed on the sales or
    revenues
    • Low rate indicates ------undervaluation
    Low price to earnings

    • The stocks with low price to earning ratio are likely to generate more
    returns and outperform the market as against the stocks with high price to
    earning ratio.
    Technical
    Anomalies
    Investors will not be
    able to beat the
    market and abnormal
    returns by using
    technical analysis.
    Calendar anomalies
    Monday weekend
    effect
    Month of the year
    effect –January
    effect
    Turn of the month
    Effect
    Monday / week end effect
    • The Monday effect is a theory which states that returns on the
    stock market on Mondays will follow the prevailing trend from
    the previous Friday.
    • Therefore, if the market was up on Friday, it should continue
    through the weekend and, come Monday, resume its rise.
    • The Monday effect is also known as the “weekend effect”.
    January Effect

    • The January Effect is a perceived seasonal increase in stock prices during


    the month of January.
    • investors use year-end cash bonuses to purchase investments the
    following month.
    Types of Anomalies

    • Fundamental anomalies
    • Technical Anomalies
    • Calendar Anomalies
    Exercise: to be done

    •Take any 2 stocks of your choice. Check if any type


    of ANOMALY holds true for that particular stock.
    Comment on the future growth prospects of the companies
    • Identify 2 growth stocks. Comment on the reasons why have you classified
    it as a growth stock?
    • You can download data from the BSE website. Example is given hereunder
    • https://www.bseindia.com/markets/equity/EQReports/StockPrcHistori.as
    px?expandable=7&scripcode=500247&flag=sp&Submit=G

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