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    Market Efficiency

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    robi atmajaya
    The document discusses market efficiency, including definitions of weak, semi-strong, and strong forms of efficiency. It examines evidence for and against efficiency, as well as anomalies such as the January effect and cross-sectional effects. Behavioral finance theories are introduced as an alternative perspective to the traditional assumption of rational investors.

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    Market Efficiency

    Uploaded by

    robi atmajaya
    42 views32 pages
    The document discusses market efficiency, including definitions of weak, semi-strong, and strong forms of efficiency. It examines evidence for and against efficiency, as well as anomalies such as the January effect and cross-sectional effects. Behavioral finance theories are introduced as an alternative perspective to the traditional assumption of rational investors.

    Original Title

    03. Market Efficiency

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    The document discusses market efficiency, including definitions of weak, semi-strong, and strong forms of efficiency. It examines evidence for and against efficiency, as well as anomalies such as the January effect and cross-sectional effects. Behavioral finance theories are introduced as an alternative perspective to the traditional assumption of rational investors.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    42 views32 pages

    Market Efficiency

    Uploaded by

    robi atmajaya
    The document discusses market efficiency, including definitions of weak, semi-strong, and strong forms of efficiency. It examines evidence for and against efficiency, as well as anomalies such as the January effect and cross-sectional effects. Behavioral finance theories are introduced as an alternative perspective to the traditional assumption of rational investors.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 32

    CHAPTER 3

    MARKET EFFICIENCY
    DEFINITION OF AN EFFICIENT
    MARKET

    Past information

    Public information
    Private
    information
    FACTORS AFFECTING MARKET
    EFFICIENCY

    Transaction costs
    Time frame of and information-
    price adjustments acquisition costs
    Market
    efficiency
    Market value
    Other factors versus intrinsic
    value
    ACTIVE VERSUS PASSIVE
    INVESTMENT STRATEGIES
    Market
    efficiency

    Active
    investment
    strategies
    FACTORS AFFECTING A MARKET’S
    EFFICIENCY
    A market should be viewed as falling on a
    continuum between two extremes:

    Continuum
    Completely Completely
    Inefficient Efficient

    Large Cap
    Stocks
    FORMS OF MARKET EFFICIENCY (FAMA
    1970)
    Market prices reflect:

    Past market Public Private


    Forms of market efficiency data information information
    Weak form of market efficiency 

    Semi-strong form of market


     
    efficiency
    Strong form of market
      
    efficiency
    WEAK FORM OF MARKET
    EFFICIENCY

    Serial
    correlation
    in security
    returns
    Tests of
    weak form
    market
    efficiency
    Usefulness
    of technical
    analysis
    SEMISTRONG FORM OF MARKET
    EFFICIENCY
    Prices reflect
    public
    information

    Fundamenta
    l analysis
    THE EVENT STUDY PROCESS
    STRONG FORM OF MARKET
    EFFICIENCY

    Past Public Private


    informatio informatio informatio Price
    n n n
    WHAT FORM OF MARKET
    EFFICIENCY EXISTS?

    Nonpublic
    informatio Abnorma
    n l profits
    QUESTIONS
    1) Is the expected return for stocks equal to zero in an
    efficient market?
    2) Which hypothesis is being tested if a researcher
    examines stock price performance following earnings
    announcements?
    3) Which hypothesis is being tested if a researcher
    examines stock price performance based on a 50-day
    and 200-day moving average of prices?
    4) Why might a stock’s price not reflect everything
    management knows about their company?
    WHAT GOOD IS FUNDAMENTAL
    ANALYSIS?

    Value-relevant
    information
    Fundamental
    analysis Possible
    abnormal
    returns
    WHAT GOOD IS TECHNICAL
    ANALYSIS?

    Usefulness of
    past data Prevalence of
    technical
    analysis
    WHAT GOOD ARE
    PORTFOLIO MANAGERS?
    Manage
    “Beat the portfolio
    market” objective
    s
    MARKET PRICING ANOMALIES

    Market
    efficiency

    Existence of
    market
    pricing
    anomalies
    EXHIBIT 3-3 SAMPLING OF
    OBSERVED PRICING ANOMALIES
    Time series Cross-sectional Other
    January effect Size effect Closed-end fund discount
    Day-of-the-week effect Value effect Earnings surprise
    Weekend effect Book-to-market ratios Initial public offerings
    Turn-of-the-month effect P/E ratio effect Distressed securities effect
    Holiday effect Value Line enigma Stock splits
    Time-of-day effect Super Bowl
    Momentum
    Overreaction
    JANUARY (TURN-OF-THE-YEAR)
    EFFECT

    Tax loss
    selling
    Other
    Window
    explanation
    dressing
    s

    January
    effect
    EXHIBIT 3-4 OTHER CALENDAR-
    BASED ANOMALIES
    Anomaly Observation
    Turn-of-the-month Returns tend to be higher on the last trading day of the month and
    effect the first three trading days of the next month.
    Day-of-the-week effect The average Monday return is negative and lower than the average
    returns for the other four days, which are all positive.
    Weekend effect Returns on weekends tend to be lower than returns on weekdays.
    Holiday effect Returns on stocks in the day prior to market holidays tend to be
    higher than other days.
    OVERREACTION AND MOMENTUM
    ANOMALIES

    • Stock prices become inflated


    Overreaction (depressed) for those companies
    anomaly releasing good (bad) news.

    • Securities that have experienced


    Momentum high returns in the short term
    tend to continue to generate
    anomaly higher returns in subsequent
    periods.
    CROSS-SECTIONAL ANOMALIES

    Value
    outperform
    Small cap s growth
    outperforms
    large cap
    CLOSED-END INVESTMENT FUNDS

    Value of
    NAV Discount closed-end
    fund
    EARNINGS SURPRISE
    Positive
    Beginning
    earnings Price rises
    price
    surprise

    Negative
    Ending price Price falls earnings
    surprise
    INITIAL PUBLIC OFFERINGS (IPOS)

    Offering
    price

    Closing price

    Abnormal
    profits
    “FRONTIERS OF FINANCE
    SURVEY”
    THE ECONOMIST (9
    OCTOBER 1993)
    Many (anomalies) can be explained away. When
    transactions costs are taken into account, the fact that
    stock prices tend to over-react to news, falling back
    the day after good news and bouncing up the day after
    bad news, proves unexploitable: price reversals are
    always within the bid-ask spread. Others such as the
    small-firm effect, work for a few years and then fail
    for a few years. Others prove to be merely proxies for
    the reward for risk taking. Many have disappeared
    since (and because) attention has been drawn to them.
    BEHAVIORAL FINANCE VERSUS
    TRADITIONAL FINANCE

    Behavioral Finance Traditional Finance


    Assumes: Assumes:
    • Investors suffer from • Investors behave
    cognitive biases that rationally.
    may lead to irrational
    decision making. • Investors process new
    information quickly
    • Investors may and correctly.
    overreact or under-react
    to new information.
    LOSS AVERSION

    Like gains

    Dislike losses
    OVERCONFIDENCE

    Investor
    overconfidence
    New Mispriced
    information securities
    OTHER BEHAVIORAL BIASES
    Representativeness

    Gambler’s fallacy

    Mental accounting

    Conservatism

    Disposition effect

    Narrow framing
    INFORMATION CASCADES

    Uninformed
    Release of Informed traders
    1 2 3
    traders imitate
    information trade
    informed traders
    IF INVESTORS SUFFER FROM
    COGNITIVE BIASES, MUST
    Theory suggests “Yes!”
    MARKETS Evidence suggests “No!”
    BE INEFFICIENT?
    If investors must be rational If all that is required for
    for efficient markets to exist, markets to be efficient is that
    then all the foibles of human investors cannot consistently
    investors suggest that beat the market on a risk-
    markets cannot be efficient. adjusted basis, then the
    evidence supports market
    efficiency.
    SUMMARY

    • Definition of efficient markets


    • Different forms of market efficiency
    • Evidence regarding market efficiency
    • Implications for fundamental analysis, technical
    analysis, and portfolio management
    • Market pricing anomalies
    • Behavioral finance

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