L 7b - EMH Flashcards
(18 cards)
What are three ways financing decisions can create value?
- Financial engineering
- Subsidies
- Asymmetric information
How do managers potentially create value with asymmetric information?
By understanding potential mispricing opportunities in the market due to managers knowing more than investors
What defines an efficient market in the context of asset pricing?
Prices fully reflect all available information
According to the EMH, what rate of return should investors expect?
Only a normal rate of return
In an efficient market, what price should firms expect to receive for newly issued securities?
Fair value (the present value of the securities)
Describe the weak form of market efficiency
Security prices reflect all information found in past prices and volume
If the weak form of market efficiency holds, is technical analysis valuble?
No
Describe the semi-strong form of market efficiency
Security prices reflect all publicly available information
Describe the strong form of market efficiency
Security prices reflect all information, public and private
What does strong form efficiency incorporate?
Weak and semi-strong form efficiency
What are some common misconceptions about market efficiency?
- Investors don’t have to worry about risk or diversification
- Dart throwing is as effective as stock picking
- Price fluctuations are predictable
- Markets can’t be efficient because only a subset of shareholders trade
What is the efficient market’s response to new information?
Prices adjust immediately
What are the three camps that financial economists have sorted themselves into?
- Market efficiency
- Behavioural finance
- Those that admit that they do not know
Name at least three empirically proven behavioural biases
- Overconfidence
- Disposition effect
- Familiarity
- Representativeness
- Conservatism
- Risk taking
Define the ‘disposition effect’ behavioural bias
Seeking pride and avoiding regret in investment decsions
What does the ‘representativeness’ bias lead to in stock returns
Overreaction
What does the ‘conservatism’ bias lead to in stock returns?
Under-reaction
