Lecture 10 Efficient Markets

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Lecture 10Efficient Markets

• Managerial Finance
• FINA 6335
• Ronald F. Singer

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Efficient Markets

• Perfect
• Capital
• Markets
• Efficient
• Capital
• Markets.

Versus
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Forms of Market Efficiency

• Weak form
• Semi-strong form
• Strong form

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Efficient Markets

• In general we can say markets are "efficient"
  with respect to some information set f if
• Expectations regarding the future price of the
  stock given the information contained in f is
  equal to the expected price given the current
  price.
• Beware of expecting too much from market
  efficiency arguments "Anomalies"

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Why Should Markets Not be Efficient?

• 1- The speed at which information is
  "disseminated" to the market
• 2- Investors Overreact

Price
Time
INF
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Why Should Markets Be Efficient?
Price
6.50
5.50
5.00
Time
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The Evidence

• Weak Form
• Definition
• Methodology Filter Rules

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Weak Form
Price

• Change position when
• stock price changes by x.
•  
• 2. Compare with buy and hold
•  
• Abnormal positive or negative
• returns imply weak form inefficiency.

Time
t-1
t
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Weak Form

• Results 
• Filter rule results in statistically significant
  abnormal returns for filters less than 1 1/2
• 1 1/2 Filter Buy
  and Hold
• 11.52 Annual Yield
  10.4
• 12,814 Number of Trades
• -103.59 Floor Traders' Return after Transaction
  Costs

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Semi-Strong Form

• Definition
• Methodology
• "Event Studies"
• 1. Define Information
• 2. Define Abnormal returns
• Models of "normal returns"
• Rit ai ßi Rmt eit Market Model
• Rit Rft ßi(Rmt - Rft) eit CAPM
• If eit 0 There are abnormal returns

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Semi-Strong Form

• Test Procedure
• FAMA, FISHER, JENSEN, ROLL(1969)
• A. Identify Firms "Announcing" Event
• B. Calculate Average residuals, cumulative
  Average residuals around the "Event Date"
• Example
• Company Announcement(t0) t -1
• ABC 9/25/80 9/24/80
• DEC 8/7/79 8/6/79
• IBM 8/3/72 8/2/79
• Then we have eit i1, ...,N, t
  -30...,0,...30

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Patterns

• Average
• Abnormal
• Residual

Cumulative Abnormal Average Residual
N ARt S 1 eit
i1 N
T CART S ARt t -30  
Results
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Strong Form Market Efficiency

• Definition
• Methodology
• Compare trades made by "insiders" to a buy and
  hold strategy
• Result

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Anomalies

• 1. Value Line
• 2. Weekend Effect
• 3. Year End Effect
• 4. Price Earnings Ratio
• 5. Small Firm
• 6. Insiders Trading
• 7.The October Stock Market Crashes
• 8. Post Announcement Drift.