Download Chapter 11: The Efficient Market Hypothesis

CHAPTER 11
The Efficient
Market
Hypothesis
Investments, 8th edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Efficient Market Hypothesis (EMH)
• Do security prices reflect information ?
• Why look at market efficiency?
– Implications for business and corporate
finance
– Implications for investment
11-2
Figure 11.1 Cumulative Abnormal
Returns Before Takeover Attempts:
Target Companies
11-3
Figure 11.2 Stock Price Reaction to
CNBC Reports
11-4
EMH and Competition
• Stock prices fully and accurately reflect
publicly available information
• Once information becomes available,
market participants analyze it
• Competition assures prices reflect
information
11-5
Versions of the EMH
• Weak
• Semi-strong
• Strong
11-6
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
11-7
Active or Passive Management
• Active Management
– Security analysis
– Timing
• Passive Management
– Buy and Hold
– Index Funds
11-8
Market Efficiency & Portfolio
Management
Even if the market is efficient a role exists for
portfolio management:
• Appropriate risk level
• Tax considerations
• Other considerations
11-9
Event Studies
• Empirical financial research that enables an
observer to assess the impact of a particular
event on a firm’s stock price
• Abnormal return due to the event is estimated
as the difference between the stock’s actual
return and a proxy for the stock’s return in the
absence of the event
11-10
How Tests Are Structured
•
Returns are adjusted to determine if they are
abnormal
Market Model approach
a. rt = at + brmt + et
(Expected Return)
b. Excess Return =
(Actual - Expected)
et = rt - (a + brMt)
11-11
Are Markets Efficient
• Magnitude Issue
• Selection Bias Issue
• Lucky Event Issue
11-12
Weak-Form Tests
• Returns over the Short Horizon
– Momentum
• Returns over Long Horizons
11-13
Predictors of Broad Market Returns
• Fama and French
– Aggregate returns are higher with higher
dividend ratios
• Campbell and Shiller
– Earnings yield can predict market returns
• Keim and Stambaugh
– Bond spreads can predict market returns
11-14
Semistrong Tests: Anomalies
•
•
•
•
•
P/E Effect
Small Firm Effect (January Effect)
Neglected Firm Effect and Liquidity Effects
Book-to-Market Ratios
Post-Earnings Announcement Price Drift
11-15
Figure 11.3 Average Annual Return for
10 Size-Based Portfolios, 1926 – 2006
11-16
Figure 11.4 Average Return as a
Function of Book-To-Market Ratio,
1926–2006
11-17
Figure 11.5 Cumulative Abnormal
Returns in Response to Earnings
Announcements
11-18
Strong-Form Tests: Inside Information
• The ability of insiders to trade profitability in
their own stock has been documented in
studies by Jaffe, Seyhun, Givoly, and Palmon
• SEC requires all insiders to register their
trading activity
11-19
Interpreting the Evidence
• Risk Premiums or market inefficiencies—
disagreement here
– Fama and French argue that these effects
can be explained as manifestations of risk
stocks with higher betas
– Lakonishok, Shleifer, and Vishney argue
that these effects are evidence of
inefficient markets
11-20
Figure 11.6 Returns to Style Portfolio as
a Predictor of GDP Growth
11-21
Interpreting the Evidence Continued
• Anomalies or Data Mining
• The noisy market hypothesis
• Fundamental indexing
11-22
Stock Market Analysts
• Do Analysts Add Value
– Mixed evidence
– Ambiguity in results
11-23
Mutual Fund Performance
• Some evidence of persistent positive and
negative performance
• Potential measurement error for benchmark
returns
– Style changes
– May be risk premiums
• Hot hands phenomenon
11-24
Figure 11.7 Estimates of Individual
Mutual Fund Alphas, 1972 - 1991
11-25
Table 11.1 Performance of Mutual Funds
Based on Three-Index Model
11-26
Figure 11.8 Persistence of Mutual Fund
Performance
11-27
Table 11.2 Two-Way Table of Managers
Classified by Risk-Adjusted Returns over
Successive Intervals
11-28