ch3 market efficiency
TRANSCRIPT
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Security prices accurately reflect availableinformation, and respond rapidly to newinformation as soon as it becomesavailable
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Weak form efficiency: prices incorporate informationabout past prices
Semi-strong form: incorporate all publicly availableinformationStrong form: all information, including insideinformation
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Reasons to Think Markets Ought to
Be EfficientMarginal investor determines pricesSmart money dominates trading
Survival of fittest
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Reasons to Doubt these ReasonsMarginal investor: wealth mattersSmart money: matter of degree. Limits to arbitrage
theorySurvival of fittest: life cycle renews
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Psychological FactorsGambling behaviorOverconfidence
Slowness to make money, futility of career trying toprove others of ones ability
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Technical AnalysisRobert D. Edwards & John Magee, Technical Analysisof Stock Trends , 1948.
Hand drawing of charts, judgmental interpretation ofpatternsDifficult to test success of technical analysis
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Head & Shoulders PatternInitial advance attracts traders, upwardmomentum. Smart money begins to distributestock, trying not to kill demand.Eventually downturn, but smart money comes into support demand, manipulation. (left shoulder)Upward momentum resumes, ends when smart
money has distributed all shares; market drops.New traders try to exploit well-known tendency torally. New weak rally, right shoulder, then abreakout. (Edwards & Magee)
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Implications of Efficiency Allocational efficiency
If markets are not allocationally efficient thenperhaps there is a ________________________
___________ in capital markets.
role for greater governmentintervention
Possible rules changes to attempt to improveallocational efficiency
Tax on trading activityMore taxes on short holding period returnsChanges in corporate compensation
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Implications of EfficiencyInformational efficiency
If markets are not informationally efficient
Investors may not be able to trust that marketprices are up to date and investors shouldthen conduct their own research (or hire aresearcher) to validate the price.
Privileged groups of investors will be able to
consistently take advantage of the generalpublic.Active strategies could outperform passivestrategies.
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Relationships between forms ofthe EMH
Notice that _______________________________ __________________ (but _____________)
Strong form efficiency would imply that __________________________________________.
semi-strong efficiency implies weakform efficiency holds NOT vice versa
both semi-strong and weak form efficiency hold