EFFICIENT MARKETS

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EFFICIENT MARKETS

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EFFICIENT MARKETS. The Efficient Market Hypothesis. Most tests of EMH: How fast information is incorporated in prices Not whether information is correctly incorporated in prices Weak Form Semi-strong Form Strong Form. Fair Game. Information set Φ t can not be used to earn excess return. - PowerPoint PPT Presentation

Transcript of EFFICIENT MARKETS

Page 1: EFFICIENT MARKETS

EFFICIENT MARKETS

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The Efficient Market Hypothesis Most tests of EMH:

How fast information is incorporated in prices Not whether information is correctly incorporated

in prices Weak Form Semi-strong Form Strong Form

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Fair Game

Information set Φt can not be used to earn excess return.

What is Φt? Weak form: past history of stock prices, company

characteristics, market characteristics, and the time of the year.

Semi-strong form: announcement of one or more pieces of information.

Strong form: all information

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The Random Walk

Visualize a roulette wheel. Returns are IID over time. Fair game does not require returns to be IID

over time. Random walk is a restricted version of the fair

game.

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Test Of Return Predictability

Time Patterns in Security Returns Returns are systematically higher or lower

depending on the time of the day, the day of the week, and the month of the year.

Intraday and Day-of-the-Week Patterns: Day-end effect. Week-end effect.

Monthly Patterns: Returns in January are substantially higher than return in

other months (January effect). Especially true for small stocks

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January and Size Effect

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Explanations of January Effect Microstructure explanation

(Keim, 1989): Last trade in December was

primarily at the bid, and this tendency was more pronounced for small stocks.

First trade in January was between bid and ask.

Return to appear high in the first few days of January.

Tax-selling hypothesis: Selling securities with

substantial losses before the year end.

This creates a tax loss which should cover more than transaction costs.

Purchasing similar securities in early January.

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Test Of Return Predictability

Predicting Return from Past Return Short-term Predictability Correlation Tests Runs Tests Filter Rules Relative Strength Very Short-term Correlation Correlation for Portfolios of Securities

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Test Of Return Predictability

Correlation over Long-run Horizons Returns and Firm Characteristics

The Size Effect Market to Book Earnings Price

Predicting Long-run Returns from Firm and Market Characteristics

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Correlation Tests

A regression of the following model:

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Correlation Tests

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Weekly Correlation Coefficients

SAHAMLag 1

(p-value)

Telekomunikasi Indonesia (TLKM)

-0,04077

(0,759393)

Gajah Tunggal (GJTL)-0,03819

(0,774214)

Gudang Garam (GGRM)-0,03858

(0,770274)

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Runs Tests

A price increase “+” A price decrease “-” No change “0” A sequence of the same sign is a “run”. + - - - +++ 0 4 runs Correlation and runs tests seem to show small

positive relationship between today’s and yesterday’s return, but on average it is very small, and frequently negative for individual securities.

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Runs Tests

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Announcement and Price Return The greatest amount of research in finance

has been devoted to the effect of an announcement on share price.

“Event Study” how fast the information was incorporated in share price.

Dozens of studies confirm that share price reacted rapidly to announcements, and in expected direction of the price change.

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Methodology of Event Studies Collect a sample of firms that had a surprise

announcement (the event) Determine the precise day of the

announcement and designate this day as “zero”

Define the period to be studied For each of the firms in the sample, compute

the return on each of the days being studied.

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Methodology of Event Studies Compute the “abnormal” return for each of

the days being studied for each firm in the sample

Compute for each day in the even period the average abnormal return for all the firms in the sample.

Often the individual day’s abnormal return is added together to compute the cumulative abnormal return from the beginning of the period.

Examine and discuss the results

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Methodology of Event Studies

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Methodology of Event Studies

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Results of Some Event Studies Market efficiency with respect to purchase or

sale of securities announcement. Whether analysts’ information could be used

to earn excess returns of if it was already incorporated in share price.

Dividend and stock split announcement.

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Results of Some Event Studies

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Results of Some Event Studies

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Strong Form Efficiency

Insider Trading Information in Analysts’ Forecasts Mutual Fund Performance

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Market Rationality

Volatility Tests Winners-Losers Market Crash of October 1987