...the disjunction effect, gambling behavior and speculation, perceived irrelevance of history, magical thinking, quasimagical thinking, attention anomalies, the availability heuristic, culture and social contagion, and global culture. Theories of human behavior from psychology, sociology, and anthropology have helped motivate much recent empirical research on the behavior of financial markets. In this paper I will survey both some of the most significant theories (for empirical finance) in these other social sciences and the empirical finance literature itself. Particular attention will be paid to the implications of these theories for the efficient markets hypothesis in finance. This is the hypothesis that financial prices efficiently incorporate all public information and that prices can be regarded as optimal estimates of true investment value at all times. The efficient markets hypothesis in turn is based on more primitive notions that people behave rationally, or accurately maximize expected utility, and are able to process all available information. The idea behind the term “efficient markets hypothesis,” a term coined by Harry Roberts (1967),1 has a long history in financial research, a far longer history than the term itself has. The hypothesis (without the words This paper was prepared for John B. Taylor and Michael Woodford, Editors, Handbook of Macroeconomics. An earlier version was presented...
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...1. Explain what efficient market hypothesis is. ` In a simple statement, the Efficient Market Hypothesis (EMH) means that security prices fully reflect all available information (Fama, 1991). There are three forms of EMH. Weak Form EMH Semi-Strong Form EMH Strong Form EMH • All past prices of a stock are reflected in today's stock price. • Technical analysis cannot be used to predict and beat a market. • All public information is calculated into a stock's current share price. • Neither fundamental nor technical analysis can be used to achieve superior gains. • All information in a market, whether public or private, is accounted for in a stock price. • Not even insider information could give an investor the advantage. Adapted from http://www.investopedia.com/exam-guide/cfa-level-1/securities-markets/weak-semistrong-strong-emh-efficient-market-hypothesis.asp#axzz27eAhlXfl The assumptions behind this hypothesis are; 1. A large number of profit-maximising participants analyse and value securities independently. 2. News regarding securities comes to the market randomly and independently. 3. Trading decisions of all the investors adjust security prices rapidly to reflect the effect of new information. . 2. Link it to the idea of the fully revealing rational expectations equilibria. The EMH is the application of Rational Expectations Theory by Muth (1961). Assuming there is only one equilibrium price, it states that outcomes do not differ systematically from what...
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...02-19-2014 FINMAN 5B 1:30-2:30 MWF D522 “TESTS AND RESULTS IN EFFICIENT MARKET HYPOTHESIS” a.) Weak Form EMH -Tests of “Statistical memory” in security prices and returns Statistical tests of independence between rates of return: * Autocorrelation tests- it is mostly support the weak-form EMH and indicates that price changes are random and some studies using more securities and more complicated tests cast some doubt. *Runs tests – it indicates randomness in prices -Tests of Trading rules Comparison of trading rules to a buy-and-hold policy * Some filter rules seem yield above-average profits with small filters, but only before taking into account the substantial transactions costs involved * Trading rule results have been mixed, and most have not been able to beat a buy-and-hold policy Problems with tests: *Cannot be definitive since trading rules can be complex and there are too many to test them all *Testing constraints- it use only publicly available data, it should include all transactions costs and it should adjust the results for risk (an apparently successful strategy may just be a very risky strategy). Results generally support the weak-form EMH, but results are not unanimous- it shows that some strategies too subjective to test and not all trading rules are disclosed. b.) Semi Strong Form EMH -Tests often involve “market-adjusted returns” It is created by subtracting the market return from the security’s return, thereby defining a security’s...
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...Efficient Market Hypothesis Efficient Market - Introduction An efficient capital market is a market that is efficient in processing information Assumptions for Market to be Efficient 1. 2. In other words, the market quickly and correctly adjusts to new information In an efficient market, the prices of securities observed at any time are based on “correct” evaluation of all information available at that time In an efficient market, prices immediately and fully reflect all available information Large no. of investors analyze and value securities for profit New information comes to the market in a random fashion 3. 4. Stock Prices adjust quickly to the new information Stock Prices should available information reflect all Definition "In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.“ - Professor Eugene Fama Efficient Market Hypothesis - Forms Efficient Market Hypothesis Weak Form Semi-Strong Form Strong Form The EMH Graphically All information, public & private • In this diagram, the circles represent the amount of information that each...
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...Introduction Efficient market hypothesis is widely accepted by academic community as a cornerstone of modern financial theory. Fama (1970) gives detailed definition of this theory and states that efficient market is a market that stock prices quickly and fully reflect all available and newly released information, where majority of participants are rational in their decision making process and where an investor is not able to outperform the market through any analyses, because of actual price of stock shows its intrinsic value. Naturally such revolutionary hypothesis did not occur suddenly. In 1990 Louis Bachelier in his "Theory of Speculation" paragraph gave definition of informational efficiency of the market. This study was not being developed until 1953 when Maurice Kendall who postulated that stock prices movement follow the random walk theory. Further enhancement of these studies associated with the name of Eugene Fama who gave comprehensive resume of efficient market hypothesis, as well as empirical evidences to support it and defined three form of efficient market: weak, semi-strong and strong in 1970 (Dimson and Mussavian, 1998). Later several different researches have been carried out by financial academics which continuously underpinned efficient market hypothesis. Consequently this theory began widely use by investors for investment decision making process. However only after two decades this hypothesis began less dominance in the market. Several crashes, changing...
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...The Efficient Market versus The Inefficient Market Many professionals have spent an endless time researching about the efficiency of the market. 5 years ago, we experienced one of the worst financial disasters in history and a lot of questions have been asked about the degree of efficiency of the market. Being in a recession has never been more dangerous because of globalization; the whole world can be affected, just like what happened in the crash of 2008. It started in the United States and went viral throughout the world. We could believe that the financial meltdown of 2008 was caused by market inefficiency but a market that is efficient can also be mispriced in some cases. If we follow the hypothesis of the efficient market, the current prices of a security should mirror the information available. The efficient market hypothesis offers three different forms: the weak form, semi strong form and strong form. The weak form states that investors are not to make unusual profits relying on historical prices. The semi-strong form commands that it is not possible to make uncommon profits solely using publicly available information due to the quick adjustment of the market which will prevent those profits. Also, using technical analysis for the semi-strong form will be useless to generate unusual profits. The third one is the strong form. It dictates that it is rarely the case when prices of securities include both the public and private information. However this form is rather...
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...Journal of Financial Economics 49 (1998) 283—306 Market efficiency, long-term returns, and behavioral finance Eugene F. Fama* Graduate School of Business, University of Chicago, Chicago, IL 60637, USA Received 17 March 1997; received in revised form 3 October 1997 Abstract Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to 1998 Elsevier Science S.A. All rights disappear with reasonable changes in technique. reserved. JEL classification: G14; G12 Keywords: Market efficiency; Behavioral finance 1. Introduction Event studies, introduced by Fama et al. (1969), produce useful evidence on how stock prices respond to information. Many studies focus on returns in a short window (a few days) around a cleanly dated event. An advantage of this approach is that because daily expected returns are close to zero, the model for expected returns does not have a big effect on inferences about abnormal returns. * Corresponding author. Tel.: 773 702 7282; fax: 773 702 9937; e-mail: eugene.fama@gsb.uchicago. edu. The comments of Brad Barber, David...
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...Financial Reporting Robert J. Bloomfield Robert J. Bloomfield is an Associate Professor at Cornell University. INTRODUCTION The most common form of the Efficient Markets Hypothesis (EMH) states that market prices fully reflect all publicly available information (Fama 1970). The EMH has been highly influential among academics, but practitioners and regulators appear unconvinced. Investors work hard to identify mispriced stocks on the basis of public data, or pay others to do so, even though the EMH asserts that such efforts are wasted. Managers seek to boost stock prices by hiding bad news in footnotes, and regulators work hard to defeat such efforts, even though the EMH asserts that information is reflected in prices no matter how obscure its presentation. Beliefs about inefficiency play a central role in the debate over recognizing expenses for incentive stock options. Opponents of expensing argue that the resulting lower net income will inappropriately reduce market prices, while proponents argue the market does not fully recognize compensation costs reported only in footnotes. In efficient markets, however, expensing these costs has no direct effect on prices, as long as the details of the compensation are included in footnotes. The decision to expense option costs could reduce stock price indirectly, even in efficient markets, by affecting the terms of contracts between the reporting firm and other parties (Watts and Zimmerman 1986). However, few of the parties to the debate...
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...SESSION TOPIC: STOCK MARKET PRICE BEHAVIOR SESSION CHAIRMAN: BURTON G. MALKIEL EFFICIENT CAPITAL MARKETS: A REVIEW OF THEORY AND EMPIRICAL WORK* EUGENE F. FAMA** I. INTRODUCTION THE PRIMARY ROLE of the capital market is allocation of ownership of the economy's capital stock. In general terms, the ideal is a market in which prices provide accurate signals for resource allocation: that is, a market in which firms can make production-investment decisions, and investors can choose among the securities that represent ownership of firms' activities under the assumption that security prices at any time "fully reflect" all available information. A market in which prices always "fully reflect" available information is called "efficient." This paper reviews the theoretical and empirical literature on the efficient markets model. After a discussion of the theory, empirical work concerned with the adjustment of security prices to three relevant information subsets is considered. First, weak form tests, in which the information set is just historical prices, are discussed. Then semi-strong form tests, in which the concern is whether prices efficiently adjust to other information that is obviously publicly available (e.g., announcements of annual earnings, stock splits, etc.) are considered. Finally, strong form tests concerned with whether given investors or groups have monopolistic access to any information relevant for price formation are reviewed.' We shall conclude that...
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...Discussing the empirical evidence supportive of and against market efficiency. Stock prices changes are said to have a similar distribution and sovereign of each other, meaning that they follow a random pattern and past movement and trends cannot be used to predict future price of a stock. Efficient market hypothesis (EMH) states that beating the market consistently is impossible as stock market efficiency causes existing share prices to always show and reflect all relevant information available in the market. According to the theory stock will always trade at their fair value on stock exchange, making it impossible for investors to purchase undervalued stocks or sell overpriced stock. But recent research has proved that gaining an abnormal profit is possible to some extent. EMH depends heavily on the level of information available in the market. In weak form efficiency all the past price movements is fully incorporated in current market price so technical analysis might not be used to predict and beat a market. While in a semi strong efficiency all public information is calculated into a stock’s current share price and in the strong form efficiency all private and public information is accounted in a stock price. Research has shown that market is efficient in all these forms. In weak form efficiency the random walk hypothesis1 is tested by testing the connection between the current return on a stock and the return on the same stock over a previous period. A positive serial...
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...Efficient Market Hypothesis * EMH emerged in the 1950s due to early application of computers in analysis of time series behaviour of economic variables. * The general idea of EMH is that markets incorporate all available information into all prices and the assumptions are that there is elimination of riskless profit opportunities and all prices of stocks are equal to their fundamental value and we have Rational expectations: agents use optimal forecasts based on all information available so as to minimise the forecast error. * In 1970 Eugine Fama defined EMH and divided it into 3 main forms. There are three main forms of EMH that are usually tested by researchers. * Weak form states that past prices have no influence on current prices or in other words it is impossible to use past information to predict future prices since all this info is already priced into stocks * Semi strong form states that market efficiency takes into account all publicly available information, past and present, such as financial reports, public announcements * Strong form states that all information, including that of insiders is reflected in prices and therefore cannot be useful in price forecasting * Early tests which focus on the performance of investment analysts and mutual funds tend to support the EMH in that past good performance does not indicate that an advisor or mutual fund will perform well in the future. For example – Jensen (1967) measures the predictive...
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...ASSIGNMENT OF INVESTMENT AND PORTFOLIO ANALYSIS Efficient Market Hypothesis (EMH) SUBMITTED TO DR. NIAMAT KHAN SUBMITTED BY SSH SHAYKH ROLL NO: 04 INSTITUTE OF MANAGEMENT STUDY UNIVERSITY OF PESHAWAR Efficient Market Hypothesis (EMH) Has been consented as one of the cornerstones of modern financial economics. Fama first defined the term "efficient market" in financial literature in 1965 as one in which security prices fully reflect all available information. The market is efficient if the reaction of market prices to new information should be immediate and impartial. Efficient market hypothesis is the initiative that information is quickly, and efficiently integrated into asset prices at any position in time, so that old information cannot be used to foretell future price movements. Therefore, three versions of EMH are being notable depends on the level of available information. TYPES OF Efficient Market Hypothesis (EMH) Weak form EMH The current asset prices already imitate past price and volume information. The information enclosed in the past succession of prices of a security is completely reflected in the current market price of that security. It is named weak form because the security prices are the most publicly and easily available pieces of information. It implies that no one should be able to smash the market using something that "everybody else knows". Yet, there are still numbers of financial researchers who are studying the past stock price cycle...
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...“THE MARKET FOR COMMERCIAL PROPERTY IS EFFICIENT” DISCUSS By: AKINDELE, DOLAPO BOSE Word Count: 2,807 FACULTY OF BUILT ENVIRONMENT UNIVERSITY OF THE WEST OF ENGLAND BRISTOL 1.0 INTRODUCTION The commercial property, as we aware, is one aspect of the property market but with a much increasing velocity, it has fast become a market to be reckoned with. Not only is it viewed as just a market type, it is now a major consideration for investors. Direct investment by UK institutions and overseas investors, attracted by the long leases and secure income, have poured huge investment into commercial property, and the market has provided an enormous valuable alternative to gilts and equities (Harris R. 2005). Though the property industry will appear to be insignificant when compared to other sectors with only two property companies, Land Securities and Canary Wharf, qualifying for inclusion in the FTSE 100, the top 100 companies by market capitalisation (value of shares), as at April 2001, importance is placed on the commercial property sector (Freeman, 2005). The property market is also of consideration to the government as well because as much as it is contributing to the economic growth of the nation – as at the end of 2003, the total value of the commercial property stock was a whopping £611bn (RICS, 2005) – it is beclouded by its own issues and failures. This purpose of the paper is to examine the commercial property market, its dynamism i.e. driver...
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...From Efficient Markets Theory to Behavioral Finance 1. What does Shiller mean by Behavioral Finance? Behavioral Finance is the collaboration between finance and other social sciences. This field of research is focused on determining the precise degree to which various market forces—including rational analysis of company-specific and macroeconomic fundamentals; human and social psychology; and cultural trends—influence investors’ expectations and determine their level of confidence or fear. Behaviorists believe that at times, the real determinants of stock market movements are the forces of human and cultural psychology, oranimal spirits (a term coined by economist John Maynar 2. How does Behavioral Finance contrast with Efficient Market Theory? Behavioral finance takes issue with two crucial implications of the EMH: (1) that the majority of investors make rational decisions based on available information; and (2) that the market price is always right. Behaviorists believe that numerous factors—irrational as well as rational—drive investor behavior. In sharp contrast to efficient markets theorists, behaviorists believe that investors frequently make irrational decisions and that the market price is not always a fair estimate of the underlying fundamental value. Still, many proponents of behavioral finance agree with at least one implication of the efficient market theory—that it’s not possible to reliably earn abnormal returns. 3. What prediction does Efficient...
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...Efficient Market Hypothesis: Examining the Case of South Asian Stock Markets Sharon Prakash Abstract This study examines the relevance of the Efficient Market Hypothesis among emerging stock markets belonging to the South Asian Association for Regional Cooperation (India, Pakistan, Sri Lanka and Bangladesh) and the Global economy. The study employs daily closing prices of eminent market indices from a time period 2004-2013.The stock returns have been subjected to unit root tests such as the Augmented Dickey Fuller test and a panel unit root test. Additionally the existence of random walk for these stock markets has also been examined through the Jarque-Bera statistic. The results indicate information inefficiency in the time period under study for all indices. Investors can therefore predict future prices on the basis of historical information, and receive excessive returns. The results have implications for developing economies wherein the government has to ensure that all asset related information be made public, to curb state interference. Introduction The concept of Efficient Market Hypothesis (EMH) holds special importance in the field of Finance, especially Capital markets. This hypothesis postulates that markets are informationally efficient. This asserts that the price of any security will fully reflect all the information that is available to the investors. That being said, one cannot consistently achieve returns that are excess of the average market returns...
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