MBA Managerial Finance Week 9         Tai Tran
In investment,Everything is reflected in   Price
Information•   Business results•   Next year performance plan•   Dividends••    M&A    Change in personnel                ...
React toInformation                Investors                         Financial                          Market   Firm     ...
React toInformation                Investors                         Financial                          Market   Firm     ...
React toInformation                   Investors                Buy/sell                financial              instruments ...
React toInformation                   Investors                Buy/sell                financial              instruments ...
React to              HowInformation                         Investors                      Buy/sell                      ...
React to               HowInformation                                  Investors                       Buy/sell           ...
React to                                      How   Information                                                      Inves...
React to              HowInformation                    Investors
React to                       HowInformation                                       Investors Stock Price   Overreaction t...
React to                         HowInformation                                           Investors           Efficient ma...
Information                                 1. All historical information                                 2. All public in...
Information                                 1. All historical information: Weak form                                 2. Al...
Information                                 1. All historical information: Weak form                                 2. Al...
A note on Technical Analysis                               Technical                               analysts               ...
Weak Form Market Efficiency• Since stock prices only  respond to new  information, which by  definition arrives  randomly,...
Why Technical Analysis is of no valueStock Price                           Sell              Sell                         ...
Semi-Strong Form Market Efficiency• All publicly available  information                           Published accounting    ...
Semi-Strong Form Market Efficiency• All information: public and  private                                     All other• St...
Implications• Investors can throw          • Prices are random or  darts to select stocks.        uncaused.  – This is alm...
Doubts?               Does the                marketAre stock    quickly and    Records of  prices      accurately   inves...
Doubts?               Optical illusions: Many                 psychologists andAre stock     statisticians believe that  p...
Event StudiesEvent studiesare tests of        Does thesemi-strong          marketform              quickly and            ...
Event Studies                                        Cumulative Abnormal Returns for CompaniesCumulative abnormal returns ...
Event StudiesThe studies                          Studies suggestgenerally                               that markets     ...
Doubts?Strong form: public and private information            Use private information:                insider tradingEvide...
React toInformation                          Irrational                                                      Investors Rep...
Small                                      stocks vs.                                         large                       ...
Implications for Corporate Finance1. The price of a companys stock cannotbe affected by a change in accounting2. Financial...
Homework• RWJ 9e, questions 1-28, page 460
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RMIT Vietnam - Managerial Finance - Efficient Market Hypothesis - Week 9

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RMIT Vietnam - Managerial Finance - Efficient Market Hypothesis - Week 9

  1. 1. MBA Managerial Finance Week 9 Tai Tran
  2. 2. In investment,Everything is reflected in Price
  3. 3. Information• Business results• Next year performance plan• Dividends•• M&A Change in personnel Financial•• Capital raising: bond issuance, stock issuance Employee stock option plan (ESOP) Market• Law suits• Industry structure• Other changes that affect the business Price
  4. 4. React toInformation Investors Financial Market Firm Price
  5. 5. React toInformation Investors Financial Market Firm Price
  6. 6. React toInformation Investors Buy/sell financial instruments Financial Market Firm Price
  7. 7. React toInformation Investors Buy/sell financial instruments Financial Market Firm Price
  8. 8. React to HowInformation Investors Buy/sell financial instruments Financial Market Firm Price
  9. 9. React to HowInformation Investors Buy/sell financial instruments Financial Market Firm Price How Supply & demand equilibrium
  10. 10. React to How Information Investors Buy/sell financial instruments Financial Market FirmIf market is efficient, Price should reflect Information Price How Supply & demand equilibrium
  11. 11. React to HowInformation Investors
  12. 12. React to HowInformation Investors Stock Price Overreaction to “good news” with reversion Delayed response to “good news” Efficient market response to “good news” -30 -20 -10 0 +10 +20 +30 Days before (-) and after (+) announcement
  13. 13. React to HowInformation Investors Efficient market Stock Delayed response to “bad news” Price response to “bad news” -30 -20 -10 0 +10 +20 +30 Overreaction to “bad Days before (-) and after (+) news” with reversion announcement
  14. 14. Information 1. All historical information 2. All public information 3. All public and private information FirmIf market is efficient, Price should reflect Information Price
  15. 15. Information 1. All historical information: Weak form 2. All public information: Semi-strong form 3. All public and private information: Strong form FirmIf market is efficient, Price should reflect Information Price
  16. 16. Information 1. All historical information: Weak form 2. All public information: Semi-strong form 3. All public and private information: Strong form Arrives randomly FirmIf market is efficient, Price should reflect Information Price
  17. 17. A note on Technical Analysis Technical analysts believe there are patterns in asset price movements. Technical analysts try to forecast future prices using these patterns.
  18. 18. Weak Form Market Efficiency• Since stock prices only respond to new information, which by definition arrives randomly, stock prices are said to follow a random walk. Past prices• Technical analysis: no value. Past volume
  19. 19. Why Technical Analysis is of no valueStock Price Sell Sell Buy Follow Profit Everybody Compe-titio Profit is elimina patterns would do it n -ted Buy Time Investor behavior tends to eliminate any profit opportunity associated with stock price patterns.
  20. 20. Semi-Strong Form Market Efficiency• All publicly available information Published accounting Statements Annual Report Past prices Past volume
  21. 21. Semi-Strong Form Market Efficiency• All information: public and private All other• Strong form efficiency says information that anything pertinent to the Published accounting stock and known to at least Statements Annual one investor is already Report incorporated into the security’s price. Past prices Past volume
  22. 22. Implications• Investors can throw • Prices are random or darts to select stocks. uncaused. – This is almost, but not – Prices reflect information. quite, true. – The price CHANGE is – An investor must still driven by new decide how risky a information, which by portfolio he wants based definition arrives on risk aversion and randomly. expected return. – Therefore, financial managers cannot “time” stock and bond sales.
  23. 23. Doubts? Does the marketAre stock quickly and Records of prices accurately investmentrandom? respond to firms new information?
  24. 24. Doubts? Optical illusions: Many psychologists andAre stock statisticians believe that prices most people want to seerandom? patterns even when faced with pure randomness.
  25. 25. Event StudiesEvent studiesare tests of Does thesemi-strong marketform quickly and accurately respond to new information?
  26. 26. Event Studies Cumulative Abnormal Returns for CompaniesCumulative abnormal returns (%) Announcing Dividend Omissions 1 0.146 0.108 0.032 0 -0.244 -0.483 -10 -5 -0.72 -1 0 5 10 -2 Efficient market -3 response to “bad news” -3.619 -4 -4.49 -4.563 -4.685 -5 -4.898 -4.747 -5.015 -5.183 -5.411 -6 Days relative to announcement of dividend omission
  27. 27. Event StudiesThe studies Studies suggestgenerally that markets Does the may even havesupport the view some foresightthat the market market into theis semi-strong quickly and future, i.e., newsform efficient. accurately tends to leak out in advance of respond to public new announcements. information?
  28. 28. Doubts?Strong form: public and private information Use private information: insider tradingEvidence: insider trading Records ofis profitable investment firms Not many do it Strong form doesnt hold
  29. 29. React toInformation Irrational Investors Representativeness: drawing Buy/sellconclusions from too little data financial instruments • Fail to diversify e.g. see a jump in a stock and • Trade too much believe that stock will rise • Holder losers • Sell winners => maximize taxes Conservativism: hold on to positions / old beliefs
  30. 30. Small stocks vs. large stocksSeasonality Evidences against EMH Value stocks vs. growth stock
  31. 31. Implications for Corporate Finance1. The price of a companys stock cannotbe affected by a change in accounting2. Financial managers cannot "time" issuesof stocks and bonds using publiclyavailable information3. A firm can sell as many shares of stocksor bonds as it desires without depressingprices
  32. 32. Homework• RWJ 9e, questions 1-28, page 460

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