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McGraw-Hill/Irwin
Corporate Finance, 7/e
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McGraw-Hill/Irwin
Corporate Finance, 7/e
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A Description of Efficient
Capital Markets
An efficient capital market is one in which stock prices
fully reflect available information.
The EMH has implications for investors and firms.
Since information is reflected in security prices quickly,
knowing information when it is released does an investor no
good.
Firms should expect to receive the fair value for securities that
they sell. Firms cannot profit from fooling investors in an
efficient market.
McGraw-Hill/Irwin
Corporate Finance, 7/e
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Overreaction to good
news with reversion
Delayed
response to
good news
Efficient market
response to good news
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McGraw-Hill/Irwin
Corporate Finance, 7/e
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+10
+20 +30
Days before (-) and
after (+) announcement
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Efficient market
response to bad news
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-20
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Overreaction to bad
news with reversion
McGraw-Hill/Irwin
Corporate Finance, 7/e
Delayed
response to
bad news
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+20
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Semi-Strong Form
Security prices
information.
reflect
all
publicly
available
Strong Form
Security prices reflect all informationpublic and
private.
McGraw-Hill/Irwin
Corporate Finance, 7/e
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Stock Price
Time
McGraw-Hill/Irwin
Corporate Finance, 7/e
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Corporate Finance, 7/e
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Corporate Finance, 7/e
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Corporate Finance, 7/e
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The Evidence
The record on the EMH is extensive, and in large
measure it is reassuring to advocates of the efficiency of
markets.
Studies fall into three broad categories:
1. Are changes in stock prices random? Are there profitable
trading rules?
2. Event studies: does the market quickly and accurately
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A matter of degree
Even if we can spot patterns, we need to have returns that beat
our transactions costs.
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McGraw-Hill/Irwin
Corporate Finance, 7/e
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Efficient market
response to bad news
S.H. Szewczyk, G.P. Tsetsekos, and Z. Santout Do Dividend Omissions Signal Future Earnings or Past Earnings? Journal of Investing
(Spring 1997)
McGraw-Hill/Irwin
Corporate Finance, 7/e
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Corporate Finance, 7/e
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McGraw-Hill/Irwin
Corporate Finance, 7/e
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Taken from Lubos Pastor and Robert F. Stambaugh, Mutual Fund Performance and Seemingly
Unrelated Assets, Journal of Financial Exonomics, 63 (2002).
McGraw-Hill/Irwin
Corporate Finance, 7/e
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McGraw-Hill/Irwin
Corporate Finance, 7/e
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Temporal Anomalies
Turn of the year, month, week.
Speculative Bubbles
Sometimes a crowd of investors can behave as a
single squirrel.
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Corporate Finance, 7/e
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Corporate Finance, 7/e
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Corporate Finance, 7/e
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Empirical Challenges
to Market Efficiency (anomalies)
Limits to Arbitrage
Markets can stay irrational longer than you can stay
insolvent. John Maynard Keynes
Earnings Surprises
Stock prices adjust slowly to earnings announcements.
Behavioralists claim that investors exhibit conservatism.
Size
Small cap stocks seem to outperform large cap stocks.
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Empirical Challenges
to Market Efficiency (anomalies)
Crashes
On October 19, 1987 the stock market dropped
between 20 and 25 percent on a Monday following a
weekend during which little surprising news was
released.
A drop of this magnitude for no apparent reason is
inconsistent with market efficiency.
Bubbles
Consider the tech stock bubble of the late 1990s.
McGraw-Hill/Irwin
Corporate Finance, 7/e
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1.
2.
3.
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Corporate Finance, 7/e
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change in accounting.
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