Market efficiency Chapter 3

Topics: Fundamental analysis, Financial markets, Stock market Pages: 32 (4820 words) Published: January 27, 2015
MARKET EFFICIENCY
Philip Fanara, Jr., Ph.D., CFA

TOPICS TO BE COVERED
Learning Outcomes
The Concept of Market Efficiency
The Description of Efficient Markets
Market Value versus Intrinsic Value
Factors Contributing to and Impeding a Market’s
Efficiency
Transaction Costs and Information-Acquisition Costs

Forms of Market Efficiency
Weak Form
Semi-Strong Form
Strong Form
Implications of the Efficient Market Hypothesis

TOPICS (CONTINUED)
Market Pricing Anomalies
Time-Series Anomalies
Cross-Sectional Anomalies
Other Anomalies
Implications for Investment Strategies

Behavioral Finance
Loss Aversion
Overconfidence
Other Behavioral Biases
Information Cascades
Behavioral Finance and Efficient Markets

Review

LEARNING OUTCOMES
discuss market efficiency and related concepts, including
their importance to investment practitioners;
explain the factors affecting a market’s efficiency;
distinguish between market value and intrinsic value;
compare and contrast the weak-form, semi-strong-form,
and strong-form market efficiency;
explain the implications of each form of market efficiency
for fundamental analysis, technical analysis, and the choice between active and passive portfolio management;
discuss identified market pricing anomalies and explain
possible inconsistencies with market efficiency;
compare and contrast the behavioral finance view of
investor behavior with that of traditional finance in
regards to market efficiency.

DEFINING EFFICIENT MARKETS
An efficient market is one in which current
market prices incorporate all available
information
Profits could be made thru collecting and
processing information when all available
information is not incorporated in current prices
Active returns refer to returns earned by
strategies that do not assume that all
information is fully reflected in market prices.
Active Returns should be contrasted with
Passive returns- A monkey throwing darts at
the list of stocks

DESCRIBING EFFICIENT MARKETS
An informationally efficient market (an efficient
market) is a market in which asset prices reflect new
information rapidly and rationally.
intrinsic= DCF
market value= price in market
Efficient market-A market in which asset prices
reflect all past and present information
Efficient Market-Passive investment (buy and hold
)strategy preferred – one that does not seek superior
risk adjusted returns- lower transactions costs, and
information search costs
Efficient Market-Active Strategy should not be
successful
Efficient Market-prices react only to “surprises” or
“unexpected” information, not fully anticipated
information

MARKET VALUE VS. INTRINSIC VALUE
Market value-current price at which stock is sold
Intrinsic value- Fundamental Value-value that
reflects a complete understanding of asset.
Bond e.g., investor would have complete understanding of:
Default risk
Liquidity of market
All issue specific items

In efficient market Market Value = Intrinsic value
If not active investing could be profitable

Intrinsic Value models require judgment re:
Size, timing, and riskiness of future cash-flows
Also, supply and demand of asset plays a role that may not
be captured in intrinsic value- sometimes need a catalytic
factor to drive market price to intrinsic value.

MARKET EFFICIENCY:
IMPEDING FACTORS

CONTRIBUTING AND

Number of Market Participants
Large number of participants and analysts following
the securities-should result in efficient market
Also need a high level of trading activity
China in past excluded foreign traders- this reduces
market efficiency

INFORMATION AVAILABILITY AND
FINANCIAL DISCLOSURE
Information availabilitylarge exchanges have

Active news media following
Numerous analyst following the assets traded
High level of trading activity
High availability of material information

Small exchanges- emerging markets lack the above

OTC markets or primarily and...
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