efficient market

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



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



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 =



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



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



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>



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



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



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



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>@



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>@



14- 12

!andom Walk Theory



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



14- 14


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



14- 15


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



14- 16


Technical Analysts

#orecast stock prices (ased on the watchin" the

fl&ct&ations in historical prices :th&s =wigglewiggle

watcherswatchers>9



14- 17


Anno&ncement ate



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



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



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



14- 21

Example: How stock splits affect value

-29 0 0

!ou"ce: Fama# Fishe"# $ensen % &oll

14 22



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



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



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

efficient market

Documents