Download Market effciency

Finanças
November 9
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Topics covered

Efficient market theory
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Definition
Implications
Foundation
Types
Evidence
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Efficient market theory

Efficient market:

Implications of the efficient market
theory:
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Reaction of Stock Price to New Information in
Efficient and Inefficient Markets
Stock
Price
Efficient market
response to “good news”
-30
-20
-10
0
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+10
+20 +30
Days before (-) and
after (+) announcement
Reaction of Stock Price to New Information in
Efficient and Inefficient Markets
Stock
Price
Efficient market
response to “bad news”
-30
-20
-10
0
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+10
+20
+30
Days before (-) and
after (+) announcement
Foundations of market efficiency
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Rationality:
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Independent deviations from rationality:
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Arbitrage
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Different types of efficiency
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Weak form:
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Semistrong form:
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Strong form:
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Weak Form Market Efficiency

Security prices reflect
Pt =
 Since stock prices only respond to new
information, which by definition arrives
randomly, stock prices are said to follow

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Semi-Strong Form of Market Efficiency
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Semi-strong form:
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Historical price and volume information
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Strong Form of Market Efficiency
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Strong form:
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Incorporates weak and semi-strong form
efficiency.

Anything pertinent to the stock and known
to at least one investor is already
incorporated into the security’s price.
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The Evidence for market efficiency

Are changes in stock prices random? Are
there profitable “trading rules”?
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Event studies: does the market quickly
and accurately respond to new
information?

The record of professionally managed
investment firms.

Insider trading
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Are Changes in Stock Prices Random?
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Random stock price changes support
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Serial correlation:
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What Pattern Do You See?
1.2
1
0.8
0.6
0.4
0.2
0
1 2
3 4 5 6 7
8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
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Are Changes in Stock Prices Random?
The serial correlation coefficients for firms
have been found to be
 The evidence is consistent with

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Event Studies
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Event studies are one type of test of the semistrong form of market efficiency
Examines prices and returns around the arrival of
new information: under reaction, overreaction,
early reaction, delayed reaction around the
event…
The abnormal return of a given stock on a
particular day:
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AR= R – RM
AR= R – (a + bRM)
Cumulative abnormal returns (CAR)
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Cumulative abnormal returns
(%)
Event Studies: Dividend Omissions
Cumulative Abnormal Returns for Companies Announcing
Dividend Omissions
1
0.146 0.108
-8
-6
0.032
-4
-0.72
0
-0.244
-2 -0.483 0
-1
2
4
6
8
Efficient market
response to “bad news”
-2
-3
-3.619
-4
-5
-4.563-4.747-4.685-4.49
-4.898
-5.015
-5.183
-5.411
-6
Days relative to announcement of dividend omission
S.H. Szewczyk, G.P. Tsetsekos, and Z. Santout “Do Dividend Omissions Signal Future Earnings or Past Earnings?” Journal of Investing
(Spring 1997)
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Event studies
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This metholdology has been applied to a
large number of corporate events
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Dividend announcement
Stock repurchase
Merger and aquisition
Earnings announcement
Change in the management etc
These studies are generally supportive of
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The Record of Mutual Funds
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If the market is semi-strong efficient, then
mutual-fund managers should
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Compare the performance of
professionally managed mutual funds with
the return on a market index.
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The Record of Mutual Funds
All funds
Smallcompany
growth
Otheraggressive
growth
-2.13%
Growth
Income
-0.39%
-2.17%
Growth and Maximum
income
capital gains
Sector
-1.06%
-0.51%
-2.29%
-5.41%
-8.45%
Taken from Lubos Pastor and Robert F. Stambaugh, “Mutual Fund Performance and Seemingly
Unrelated Assets,” Journal of Financial Exonomics, 63 (2002).
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Insider trading
Trades by insiders are found to be related
to large profits.
 The evidence is
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Behavial challenge to market efficiency
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Investors do not behave rationally
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Patterms in deviation from rationality
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Arbitrage is risky
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Empirical Challenges
to Market Efficiency
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