Post on 14-Apr-2018
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 1/24
14- 1
Topics Covered
We Always Come Back to NPV
What is an Efficient Market?
!andom Walk
Efficient Market TheoryThe Evidence A"ainst Market Efficiency
Behavioral #inance
$essons of Market Efficiency
%mplications
Essentials
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 2/24
14- 2
!et&rn to NPV
NPV employs disco&nt ratesThese disco&nt rates are risk ad'&sted
The risk ad'&stment is a (yprod&ct of
market esta(lished pricesAd'&sta(le disco&nt rates chan"e asset
val&es
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 3/24
14- 3
!et&rn to NPV
ExampleThe "overnment is lendin" yo& )*++,+++ for *+
years at -. and only re/&irin" interest payments
prior to mat&rity0 1ince -. is o(vio&sly (elow
market, what is the val&e of the (elow market rateloan?
repaymentloanofPV2
pmtsinterestofPV2(orrowedamo&ntNPV =
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 4/24
14- 4
!et&rn to NPV
Example
The "overnment is lendin" yo& )*++,+++ for *+ years at -. and only
re/&irin" interest payments prior to mat&rity0 1ince -. is o(vio&sly
(elow market, what is the val&e of the (elow market rate loan?
Ass&me the market ret&rn on e/&ivalent risk pro'ects is *+.0
+*3,4-)
566,78+++,*++
9*+0*:
+++,*++
9*+0*:
+++,-+++,++*NPV
*+
*+
*
=
−=
−
−= ∑
=t t
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 5/24
14- 5
EM;
Efficiency <how s&ccessf&l is the market inesta(lishin" share prices that reflects the =worth>
of the shares@0is new info incorporated in a
rapid and &n(iased manner the speed and /&ality
of price ad'&stment to new informationEM; is a s&(set of the !ational Epectation
;ypothesis :!E;9 <in a competitive world,
economic a"ents will eploit all availa(le
information to take advanta"e of any perceived
profita(le opport&nities@that will eliminate
opport&nities for a(normal "ains
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 6/24
14- 6
EM;
e"rees of efficiency Perfect, Near Efficiency and %nefficiency
Near efficiency one that capt&res a partic&lar info set in
its share prices in s&ch a way as to prevent all (&t the most
skillf&l investors from earnin" ecess ret&rns from thesame information@0
:Weak, 1emi21tron" and 1tron" form9
#actors contri(&tin" to market inefficiency
2 The information "ap Biased !eportin"
Personal Eperience2 =(eatin" the market>
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 7/24
14- 7
!andom Walk Theory
The movement of stock prices from day today D NDT reflect any pattern0
1tatistically speakin", the movement of
stock prices is random (skewed positive over thelong term).
#actors that contri(&te towards <"eneratin"
prices that f&lly reflect the worth of assets
(ein" traded
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 8/24
14- 8
EM;
;omo"eneity all shares are viewed in terms ofrisks and epected ret&rns, which provides some
de"ree of compara(ility within the price str&ct&re
of the sec&rities market that distin"&ishes it
si"nificantly from most other markets0 Thisred&ces the compass of informational demand and
esta(lishes the foc&s on risk and epected ret&rns0
$ocation %ndependence val&es of shares of the
same company traded in different echan"es is
independent of location :&nlike tan"i(le assets like
an apartment or a chair90 This red&ces the ran"e of
investors potential information needs0
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 9/24
14- 9
EM;
%nformation s&pport The o&tstandin" feat&res ofany sec&rities market is <how or"anied and
ela(orate is the information machinery which
services it0 %t concerns not only the /&ality and
the amo&nt of information s&pply (&t e/&allyimportant is the rapidity with which the
information is disseminated amon" the market
participants0 This provides motivation for rapid
and widespread information dissemination0
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 10/24
14- 10
EM;
%nterpretations a(o&t nat&re of marketefficiency@00
=1&rely, the market is always ri"ht>@0
=EM; ass&mes that all investors (ehaverationally>@
=1tock market (&((les imply inefficiency>@
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 11/24
14- 11
EM;
%nterpretations on evidence for marketefficiency
=Efficiency applies only to certain shares>@
=1tatistical evidence is ins&fficient>@0 =Prices are determined (y s&pply and
demand>@
=Whilst there may (e little scope in the lon"
term for achievin" a(ove avera"e profits, therewill always (e occasional short term
opport&nities>@
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 12/24
14- 12
!andom Walk Theory
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 13/24
14- 13
Efficient Market Theory
$ast
Month
This
Month
Net
Month
)4+
-+
3+
MicrosoftStock Price
Cycles
disappear
once
identified
Act&al price as soon as &pswin" is
reco"nied
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 14/24
14- 14
Efficient Market Theory
Weak #orm Efficiency Market prices reflect all historical information
1emi21tron" #orm Efficiency
Market prices reflect all p&(licly availa(leinformation
1tron" #orm Efficiency
Market prices reflect all information, (othp&(lic and private
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 15/24
14- 15
Efficient Market Theory
Fundamental Analysts
!esearch the val&e of stocks &sin" NPV and other
meas&rements of cash flow
Meas&res the impact of the chan"es in the market,ind&stry and the firm on the firms share price
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 16/24
14- 16
Efficient Market Theory
Technical Analysts
#orecast stock prices (ased on the watchin" the
fl&ct&ations in historical prices :th&s =wigglewiggle
watcherswatchers>9
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 17/24
14- 17
Efficient Market Theory
Anno&ncement ate
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 18/24
14- 18
Behavioral #inance
Ar(itra"e limitations2 limits for rationalinvestors to eploit market inefficiencies@
the risk that prices will diver"e even f&rther
(efore they conver"e
$TCM eample
Why mi"ht prices depart from f&ndamental
val&es?*0 Attit&des towards risk
30 Beliefs a(o&t pro(a(ilities
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 19/24
14- 19
$essons of Market Efficiency
Markets have no memory :weak form efficient9
Tr&st market prices :yo& cannot consistently earn
s&perior ret&rns &nless yo& have inside
information9
!ead the entrails :the detailed info re/&ired to
assess the f&t&re prospects9
There are no financial ill&sions :investors read
reported fi"&res at face val&eF000the case of #%#Dand $%#D in times of increasin" inflation@9
The do it yourself alternative
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 20/24
14- 20
$essons of EM;
1een one stock, seen them all
: BGT %nvestors (&y stock for its prospects of
fair ret&rns for its risk0 The for stocks
are &s&ally hi"hly E$A1T%CF0 %f prospects"ood everyone scram(les for the share and
if prospects are not "ood, everyone avoids
the share0 Block trades will affect prices
&nless can convince other investors that yo&
have no private information9
14 21
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 21/24
14- 21
Example: How stock splits affect value
-29 0 0
!ou"ce: Fama# Fishe"# $ensen % &oll
14 22
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 22/24
14- 22
Market Efficiency
%mplications of a fairly efficient market Earn normal ret&rns on consistent (asis
No spec&lative profits
%nvestment 1trate"y Passive No val&e for #&ndamental and Technical
strate"ies for analysts
*0 What is the difference (etween <efficiency and
<rationality?
30 What is meant (y <parado of market efficiency?
-0 %s there s&ch thin" as <a(sol&te efficiency? Why?
14 23
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 23/24
14- 23
Essentials for market efficiency
*0 Characteristics of the sec&rity and the iss&er
30 Characteristics of the market in the sec&rity trades
-0 The efficiency of technolo"y availa(le to analysts to
"ather and process information and to trade
$ar"er firms are perceived to (e more efficient thansmaller firms, (eca&se
They en'oy (etter economies of scale in prod&ction and processin"
of information and as well as tradin"
They en'oy lower costs of tradin", commissions and (id2ask
spread They possess efficient technolo"ies to identify deviations of prices
and val&e and have the means to correct these deviations /&ickly
as they have efficient technolo"ies to process info and tradin"0
14 24
7/27/2019 Efficient Market
http://slidepdf.com/reader/full/efficient-market 24/24
14- 24
Case and !eadin"s
'ase:
Bill Miller and Val&e Tr&st :!efer to Pa"es 3-2-6 of the
Book, Case 1t&dies in #inance Mana"in" for Corporate
Val&e Creation, (y !o(ert #0 Br&ner, Henneth M0 Eades
and Michael I0 1chill, 8th Edition, McJraw2;ill
%nternational Edition, 3+*+90
A"ticles
*0 M0 !&(instein, !ational Markets Kes or No?, The
Affirmative Case?The #inancial Anaysts Io&rnal 7L
:MayI&ne 3++*9, pp *72350
30 B0J0 Malkiel, Efficient Market ;ypothesis and its
critics, Io&rnal of Economic Perspectives *L, Winter 3++-,
pp 752630