investments notesLecture 13.doc

此文档收集于网络，如有侵权，请联系网站删除Lecture 13Market EfficiencyMarket efficiency refers to information efficiency the efficiency with which information is impounded in asset price.Efficient market hypothesis EMH - all relevant information is quickly impounded in asset prices and investors can only earn a return that is commensurate with the level of risk of the asset.How to characterize market efficiency?Let ARit = abnormal return for stock i at period tARit = Actual return expected equilibrium return based upon available informationIf CAPM is assumed,ARit= Rit E(Rit, SMLl It-1) It-1 is the information set available to investors at time t-1Under EMH, ARi should be purely random, i.e. contain no predictable pattern ARi has a zero mean and are serially uncorrelated EMH does not require Rit = E(Rit,SML), or ARit = 0 at all time. Ri can overshoot or undershoot E(Rit,SML) as long as the deviations are not persistent (and hence become a systematic pattern).EMH only requires actual return (price) to be an unbiased estimate of the equilibrium return (price).If EMH is not valid, ARi is not “random”, i.e. has non-zero mean or are serially correlated. asset price fails to reflect all information e.g. If ARi has a positive mean investors did not act on this information (if they did, Pi , Ri and ARi)In an inefficient market, assets are mispriced for a time period long enough for profit opportunity to arise.ExampleSuppose a positive news is announcedUnder EMH, asset price immediately jump to the new equilibrium level news. No abnormal return.If EMH is not valid, If price adjusts slowly with lags, this leads to persistent positive ARi investors should be able to earn an abnormal return if they buy and hold. If price over-reacts to the news, this leads to persistent negative ARi investors should be able to earn an abnormal return if they short sell the stockTest of EMH is a joint test of two hypotheses:1) the asset pricing model used is correct2) investors behave rationally i.e. in forming their expectation, they use all the available information (hence do not make systematic forecast errors)Implication:Researchers in rejecting EMH cannot discern whether the rejection is due to the irrationality of market participants or misspecification of the asset pricing model.Why care about market efficiency?Investors care market efficiency can affect their investment strategy: active vs. passive.In an efficient market, stock price already reflects all information.Active management of portfolio through technical and fundamental analyses is useless. Companies care they can extract useful information from market price. If the market is efficient, they will listen to the markets verdict. Some mergers are aborted because of unfavorable reception by the market.Government cares an efficient market makes sure resources are allocated to their most valuable uses. Companies with solid fundamentals will get more capital than companies. In an inefficient market, overvalued firm could obtain capital too cheaply and invest in projects that should not have done while undervalued firms would have to forgo profitable investment projects because the cost of raising capital is too high. Large adjustment costs from resource misallocation. E.g. Bursting of the Internet stock bubble.Role for portfolio management in an efficientmarket1) Cannot choose stocks in random must diversify to reduce firm-specific risk.2) Tax A persons tax status can affect his portfolio choice. The same portfolio can be bad for one investor but very good for another.3) Risk profile of investors matters* Age, job, risk aversionWhy capital market can be inefficient?(1) People are irrational Loss aversionInvestors feel the pain of a loss more than the pleasure of a win. Investors tend to be reluctant to realize losses and too eager to take profit.Studies have shown that investors are 50% more likely to sell winners than losers.e.g. Positive news Stock price increases But the rise might be reduced by premature selling. Hence, stock price may be below its fair market level until such selling pressure abates.e.g. Negative news Stock price decreases But the decline might be reduced by investors “falling in love” with their stocks. Hence, stock price may be above its fair market value until such these investors eventually sell. Conservatism Tendency to react slowly to new information that is contrary to prior belief.Implication for EMH: investors may under-react to news. RepresentativenessTendency to project what we know onto something that wedo not know. e.g. winning stocks are projected to continue to do well.Implication for EMH: investors over-react to a stocks good historical performance.(2) Information costs It is costly to obtain and process information. Hence, it takes time for price to reflect new information.(3) Trading restrictionsIf trading activities are restricted, mispricing can persist.e.g. Some money managers trade under investment restrictions (exposure limits to some sectors, short-selling, gearing, etc.) e.g. If short-selling is restricted, then stock prices are likely to be biased upward.(4) Trading costsBid-ask spread, brokerage fee, impact cost large trade can affect market price and reduce trading profit.Implication: Even if EMH may not hold before transaction costs, it may do so after such costs are taken into account.(5) Insufficient capital Institutional investors may not be interested in some firms that they do not follow (neglected firms). Three versions of EMHEMH can be more precisely defined with reference to the information set available to investors It-1. 1. Weak form of EMHMarkets are said to be “weakly” efficient if prices reflect all past price information (e.g. past prices and turnover).Implication: Investors cannot earn abnormal return using technical analysis.2. Semi-strong form of EMHMarkets are said to be “semi-strongly” efficient if prices reflect all publicly available information (besides past price data, also include such info as earning forecasts, new product developments, financial statements, industry trends, etc). Implication: Investors cannot earn abnormal return by acting on public information after its announcement.3. Strong form of EMHMarkets are said to be “strongly” efficient if prices reflect all information, whether it is publicly available or privately held such as insider information.Market Anomalies1. Calendar anomalies(a) January effect JE the phenomenon of unusually large positive returns during the first few trading days in January JE usually occurs to loser stocks that have poor prior-year performance. Tax-loss selling can be a possible explanation as investors are likely to sell their losing stocks toward year-end to realize capital loss. JE is especially strong for small-cap stocks. Studies of JE are based on data in the 1980s, but JE has been weak to nonexistent in recent years and seem to have moved to November and December.More recent data 1990s: December and May are best 2000-2007: October and November are best(b) December effect - appreciation of winner stocks in the last few days of December.Tax-gain selling may be an explanation: Investors may delay selling winning stocks to postpone payment of capital gain taxes. (c) Holiday effect the regularity of unusually good performance for stocks on the day prior to holidays.(d) Weekend Effect - the pre-weekend positive return (on Friday) and the post-weekend negative effect (Monday effect). Weekend effect is larger for long weekends (a hybrid of holiday and weekend effect) Weekend effect can be explained by unhedged short sellers who need to close out their positions at the end of a week and reopen them the following Monday.(e) Beginning-of-the-day effect tendency of stock prices to rise during the beginning ( 30 to 45 minutes) of a trading day from Tuesday to Friday (excludes Monday)(f) End-the-day effect tendency of stock prices to rise near the close of the trading day.(g) Political-cycle effect tendency of stock prices to rise during the 3rd and 4th years of a presidential administration. (h) Last-digit-of-the year effect High stock returns during the years ending with t