Efficient-Market-Hypothesis

EFFICIENT/INEFFICIENTMARKETSChaohuaHeOutlineEfficientMarketsInefficientMarketsEventStudyMethodologiesEventStudyinCSRImplicationsEfficientMarketsTheEfficientMarketHypothesis•Amarkettheorythatevolvedfroma1960'sPh.D.dissertationbyEugeneFama(2013Nobellaureateineconomicsciences),theefficientmarkethypothesisstatesthatatanygiventimeandinaliquidmarket,securitypricesfullyreflectallavailableinformation.•Thistheorycontendsthatsincemarketsareefficientandcurrentpricesreflectallinformation,anyattemptto“beat”themarketturnsouttobeluckratherthanskill.()TheEfficientMarketHypothesisThreeforms:•Weak-formEMH•Semi-strong-formEMH•Strong-formEMHThestrictnessofdefiningmarketefficiencyincreasesinorder.TheEfficientMarketHypothesisTheWeak-formEMH•Currentstockpricesfullyreflectallcurrentlyavailablesecuritymarketinformation.•Historicalpricesandmarketinformationcannotbeusedtopredictthefuturedirectionofsecurityprices.•Oftenweak-formefficiencyisrepresentedasPt=Pt-1+Expectedreturn+randomerrort•Sincestockpricesonlyrespondtonewinformation,whichbydefinitionarrivesrandomly,stockpricesaresaidtofollowarandomwalk.•Excessreturnscannotbeachievedusingtechnicalanalysis.WhyTechnicalAnalysisFails•Investorbehaviortendstoeliminateanyprofitopportunityassociatedwithstockpricepatterns.Thatis,noprofitopportunitywillconsistentlyexist.TheEfficientMarketHypothesisSemi-strong-formEMH•Currentstockpricesrespondrapidlytoallnewpublicinformation.•Securitypriceshavecapturedavailablemarketandnon-marketpublicinformation.•Excessreturnscannotbeachievedusingfundamentalanalysis.TheEfficientMarketHypothesisStrong-formEMH•Currentstockpricesfullyreflectallpublicandprivateinformation.•Non-marketandinsideinformationisfullyincorporatedintosecurityprices.Monopolisticinformationisinaccessible.•Marektissoperfectthatexcessreturnsareimpossibletoachieveconsistently.(Note:momentaryexcessreturnispossible,butthemarketwillcorrectanymispricingsquicklyandexcessreturnswilldisappearshortly)WhattheEMHDoesandDoesNOTSay•Investorsareabletoselectstocks•Thisisnotalwaystrue.•However,investorsareabletomakedecisionsbasedontheirriskaversionandlevelofexpectedreturn.•Pricesarerandom•Pricesreflectinformation.•ThepriceCHANGEisdrivenbyNEWinformation,whichhypotheticallyarrivesrandomly.•Investmentmanagersareunableto“time”securitytransactions.TheEfficientMarketHypothesisEMHTechnicalAnalysisFundamentalAnalysisWeak-formNOYESSemi-strong-formNONOStrong-formNONOTechnicalAnalysisVSFundamentalAnalysisTechnicalAnalysis•Anapproachofevaluatingsecuritiesbyanalyzinghistoricalprices,volumeandothermarketinformation.•Notaimedatachievingasecurity'sintrinsicvalue.Visionintothefutureiscontingentuponhistoricalpatternsderivedfromchartsandothertools.•Assumption:thehistoricalperformanceofstocksandmarketsareindicationsoffutureperformance.TechnicalAnalysisVSFundamentalAnalysisFundamentalAnalysis•Anapproachofevaluatingasecuritythatentailsattemptingtomeasureitsintrinsicvaluebyexaminingrelatedeconomic,financialandotherqualitativeandquantitativefactors.•Analyzewhatsoeverinformationthatcanaffectthesecurity'svalue,includingmacroeconomicinformation(suchastheoveralleconomyandindustryconditions)andcompany-specificinformation(likefinancialcondition,managementandcompany-relatedevents).•Aimedatderivinganintrinsicvalueforasecurity,withwhichaninvestorcancomparethecurrentpricebeforemakinginvestmentdecisions.(underpriced=buy,overpriced=sell).TraitsofMarketEfficiency•FourBasicTraitsofMarketEfficiency1.Acttonewinformationquicklyandaccurately2.Pricemovementisunpredictable3.Notradingstrategyconsistentlyoutperformsthemarket4.InvestmentprofessionalscannotdobetterthanthemarketTraitOne:ReactionofStockPricetoNewPositiveInformationinEfficientandInefficientMarkets(1)TraitOne:ReactionofStockPricetoNewPositiveInformationinEfficientandInefficientMarkets(2)TraitOne:ReactionofStockPricetoNewNegativeInformationinEfficientandInefficientMarkets