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The Efficient Market Hypothesis

The Efficient Market Hypothesis. Efficient Market Hypothesis (EMH). Do security prices reflect information ? Why look at market efficiency Implications for business and corporate finance Implications for investment. Forms of the EMH. Weak Semi-strong Strong. Types of Stock Analysis.

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The Efficient Market Hypothesis

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  1. The Efficient Market Hypothesis

  2. Efficient Market Hypothesis (EMH) • Do security prices reflect information ? • Why look at market efficiency • Implications for business and corporate finance • Implications for investment

  3. Forms of the EMH • Weak • Semi-strong • Strong

  4. Types of Stock Analysis • Technical Analysis - using prices and volume information to predict future prices • Weak form efficiency & technical analysis • Fundamental Analysis - using economic and accounting information to predict stock prices • Semi strong form efficiency & fundamental analysis

  5. Random Walk Hypothesis • Why are price changes random? • Prices react to information • Flow of information is random • Therefore, price changes are random

  6. Random Walk with Positive Trend Security Prices Time Irwin/McGraw-Hill 9-4 • The McGraw-Hill Companies, Inc., 1998

  7. Empirical Tests of Market Efficiency • Event studies • Assessing performance of professional managers • Testing some trading rule

  8. Returns Over Time -t 0 +t Announcement Date Irwin/McGraw-Hill 9-13 • The McGraw-Hill Companies, Inc., 1998

  9. What Does the Evidence Show? • Technical Analysis • Fundamental Analysis • Anomalies Exist

  10. Anomalies • Small Firm Effect (January Effect) • Neglected Firm • Market to Book Ratios • Reversals • Value Line Enigma • Post-Earnings Announcement Drift • Higher Level Correlation in Security Prices

  11. Mutual Fund and Professional Manager Performance • Some evidence of persistent positive and negative performance • Potential measurement error for benchmark returns • Style changes • May be risk premiums • Superstar phenomenon

  12. Implications of Efficiency for Active or Passive Management • Active Management • Security analysis • Timing • Passive Management • Buy and Hold • Index Funds

  13. Market Efficiency and Portfolio Management Even if the market is efficient a role exists for portfolio management • Appropriate risk level • Tax considerations • Other considerations

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