QDai for FEUNL

Finanças

November 9

QDai for FEUNL

Topics covered Efficient market theory

Definition Implications Foundation Types Evidence

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Efficient market theory Efficient market:

Implications of the efficient market theory:

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Reaction of Stock Price to New Information in Efficient and Inefficient Markets

Stock Price

-30 -20 -10 0 +10 +20 +30Days before (-) and

after (+) announcement

Efficient market response to “good news”

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Reaction of Stock Price to New Information in Efficient and Inefficient Markets

Stock Price

-30 -20 -10 0 +10 +20 +30

Days before (-) and after (+)

announcement

Efficient market response to “bad news”

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Foundations of market efficiency Rationality:

Independent deviations from rationality:

Arbitrage

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Different types of efficiency Weak form:

Semistrong form:

Strong form:

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Weak Form Market Efficiency Security prices reflect

Pt = Since stock prices only respond to new

information, which by definition arrives randomly, stock prices are said to follow

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Semi-Strong Form of Market Efficiency Semi-strong form:

Historical price and volume information

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Strong Form of Market Efficiency Strong form:

Incorporates weak and semi-strong form efficiency.

Anything pertinent to the stock and known to at least one investor is already incorporated into the security’s price.

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The Evidence for market efficiency Are changes in stock prices random? Are

there profitable “trading rules”? Event studies: does the market quickly

and accurately respond to new information?

The record of professionally managed investment firms.

Insider trading

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Are Changes in Stock Prices Random? Random stock price changes support

Serial correlation:

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What Pattern Do You See?

0

0.2

0.4

0.6

0.8

1

1.2

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

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Are Changes in Stock Prices Random? The serial correlation coefficients for firms

have been found to be The evidence is consistent with

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Event Studies Event studies are one type of test of the semi-

strong form of market efficiency Examines prices and returns around the arrival of

new information: under reaction, overreaction, early reaction, delayed reaction around the event…

The abnormal return of a given stock on a particular day: AR= R – RM

AR= R – ( + RM)

Cumulative abnormal returns (CAR)

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Event Studies: Dividend Omissions

Cumulative Abnormal Returns for Companies Announcing Dividend Omissions

0.146 0.108

-0.72

0.032-0.244-0.483

-3.619

-5.015-5.411-5.183

-4.898-4.563-4.747-4.685-4.49

-6

-5

-4

-3

-2

-1

0

1

-8 -6 -4 -2 0 2 4 6 8

Days relative to announcement of dividend omission

Cum

ulat

ive

abno

rmal

ret

urns

(%

)

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)

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Event studies This metholdology has been applied to a

large number of corporate events Dividend announcement Stock repurchase Merger and aquisition Earnings announcement Change in the management etc

These studies are generally supportive of

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The Record of Mutual Funds If the market is semi-strong efficient, then

mutual-fund managers should

Compare the performance of professionally managed mutual funds with the return on a market index.

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The Record of Mutual Funds

Taken from Lubos Pastor and Robert F. Stambaugh, “Mutual Fund Performance and Seemingly Unrelated Assets,” Journal of Financial Exonomics, 63 (2002).

-2.13%

-8.45%

-5.41%

-2.17% -2.29%

-1.06%-0.51%-0.39%

All funds Small-companygrowth

Other-aggressive

growth

Growth Income Growth andincome

Maximumcapital gains

Sector

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Insider trading Trades by insiders are found to be related

to large profits. The evidence is

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Behavial challenge to market efficiency Investors do not behave rationally

Patterms in deviation from rationality

Arbitrage is risky

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Empirical Challengesto Market Efficiency