Market Efficiency Flashcards
What is an efficient market?
- It is a market where security prices adjust rapidly to reflect any new information.
- It is difficult to find inaccurately priced securities.
- The time frame required for security prices to reflect any new information is very short.
What is an inefficient market?
- Securities may be mispriced, and trading in these securities can offer positive risk-adjusted returns.
- The time frame of the price adjustment is long enough to allow many traders to earn profits with little risk.
What is the intrinsic value?
It reflects all its investment characteristics accurately.
How is value interpreted in an efficient and inefficient market?
- Efficient market: market prices reflects a security’s intrinsic value.
- Inefficient market: investors may try to develop their own estimates of intrinsic value in order to profit from any mispricing.
What are the factors contributing to and impeding a market’s efficiency? Describe them.
- Market participants: the greater the # of active market participants, the greater the degree of efficiency in the market.
- Information availability and financial disclosure: accurate and timely information regarding trading activities and traded companies contribute to market efficiency.
- Limits to trading: activities of arbitrageurs contribute to market efficiency.
- Transactions costs and information acquisition costs: investors should consider transaction costs and information-acquisition costs in evaluating the efficiency of a market.
What do proponents of weak-for efficient market hypothesis (HEM) say?
Abnormal returns cannot be earned by using trading rules and technical analyses that make investment decisions based on historical security market data.
What do proponents of semistrong-form EMH say?
Investors cannot earn abnormal risk-adjusted returns if their investment decisions are based on important information after is has been made public.
What happens under strong-form EMH?
No one can consistently achieve abnormal risk-adjusted returns. It assumes that information is cost-free and available to all.
What are the implications of EMH?
- Securities markets are weak-form efficient, so past price trends cannot be used to earn superior risk-adjusted returns.
- Securities markets are also semi-strong form efficient, so information is already factored into a security’s price and how any new information may affect its value.
- Securities markets are not strong-form efficient because insider trading is illegal.
After accounting for risks and transaction costs, should technical trading rules generate abnormal risk-adjusted profits?
No, it shouldn’t happen because of the weak market presence.
What does fundamental analysis and efficient markets are related?
- It is necessary for a well-functioning securities market as it helps market participants understand the complications of any new information.
- It helps generate abnormal risk-adjusted returns if an analyst is superior to her peers in valuing securities.
What is the implication of efficient markets in portfolio management?
The role is not necessarily to beat the market but to manage the portfolio in light of the investors’ risk and return objectives.
When does an anomaly occur in securities pricing?
It occurs when an asset’s price change cannot be explained by the release of new information into the market.
What are the time-series anomalies types? Describe them.
- January effect: investors have earned significantly higher returns in the equity market during January compared to other months of the year.
- Momentum and overreaction anomalies: process arise as a result of investors overreacting to the release of new information.
What are the cross-sectional anomalies?
- Size effect: shares of smaller companies outperformed shares of larger companies on a risk-adjusted basis.
- Value effect: low P/E stocks have experienced higher risk-adjusted returns than high P/E stocks.
