Lecture 17 - Efficient Capital Markets and Behavioural Finance

Question 1

Efficient Market Hypothesis

Answer 1

An efficient capital market is one which share prices fully reflect available information

Question 2

What does EMH mean for investors?

Answer 2

Investors should only expect to obtain a normal rate of return as information is reflected in prices

Question 3

What does EMH mean for companies?

Answer 3

Firms should expect to receive fair value for securities tat they sell meaning the price is the present value

Question 4

The three foundations of market efficiency

Answer 4

Rationality - Investors respond to new information rationally

Arbitrage - Rational professionals can correct market areas by trading on them

Independent deviations from rationality - Irrational responses offset eachother

Question 5

Three types of efficiency in a market

Answer 5

Weak - Market incorporates past prices

Semi-strong - Market incorporates past prices and publicly available information

Strong - Market incorporates past prices and all available information

Question 6

3 common misperceptions about market efficiency

Answer 6

The efficacy of dart throwing
Price fluctuations
Shareholder disinterest

Question 7

The efficacy of dart throwing

Answer 7

The EMH does not imply that choosing investments is like throwing darts

You still need to decide on your risk tolerance

EMH does however say that in general the price is right for the investments you choose

Question 8

Empirical challenges to market efficiency

Answer 8

Size
Crashes and bubbles
Earnings surprises
Value vs growth
Limits to arbitrage