investments notesLecture 14 class revised.doc

此文档收集于网络，如有侵权，请联系网站删除Lecture 13Test of weak form of EMHa) Profitability of trading rulesCheung and Wong (1997) Trading rules (e.g. moving average and filter rule) cannot outperform a naive buy-and-hold trading strategy in the foreign exchange market after accounting for bid-ask spread and risk premium. Bessembinder & Chan (1995)Some simple forms of technical trading rules can beat buy-and-hold strategy for some emerging Asian stock markets but not for more developed markets such as Hong Kong and Japan. The observation that technical trading rules have predictive power for changes in some Asian stock market indices is consistent with the reasoning that these markets are inefficient.b) Serial correlation testsSerial correlations between returns mean stock returns are related to the past returns. Positive correlation means positive (negative) returns tend to follow positive (negative) returns - momentum property.Negative correlation means positive (negative) returns tend to follow negative (positive) returns - reversal property.In a weakly efficient market, asset price should not have serial correlation; otherwise profit opportunity will exist (if enough to cover transaction cost).Evidence so far is conflicting.But it appears than stock returns have short-run positive correlations (weekly, monthly, and quarterly).However, long-horizon returns (over a few years) tend to show negative correlation.A possible interpretation is stock prices over-react to news in the short-run, leading to momentum effect. Subsequent correction leads to the negative correlation over the long-run.No conclusive evidence that investors can make abnormal profit from past price data after accounting for risk and transaction cost. These anomalies are unlikely to generate profit opportunities after accounting for transactions costs and risk. They are diminishing too. Tests of semi-strong form of EMHThese tests are mainly in the context of fundamental analysis as it uses a much wider range of information than technical analysis. PE ratio predicts abnormal return (Basu, 1977, JF)Low P/E portfolio return high P/E portfolio return even after adjusting for beta.This can indicate market inefficiency or CAPM fails to capture the entire risk premium. (see Figure 11.4)Post-earnings-announcement price driftSluggish response of stock prices to earning surprises afterthe announcement date. (see Figure 11-5)Main difficult is in interpreting the result is we cannot prove whether the rejection of EMH is due to market inefficiency or invalid asset pricing model.Testing of strong form of EMHStudies by Jaffe (1974) and Seyhun (1986) show that - Insiders can earn abnormal return (but recall this is illegal). May not be profitable after accounting for legal risk. Even if they do, the profit is not impressive.- Outsiders are unlikely to make a profit by following insiders trading pattern once insider trading information becomes public. Mutual fund performance (see Figure 11-7, 11-8)Other findings:- Large funds perform no better than small funds- Funds charging a load fee perform slightly worse than no-load funds- Funds with high management fees perform slightly worse than funds with low management feesHow to judge is a mispricing actual exist?(1) Is the model of equilibrium return correct?(2) Still exists after transaction costs?(3) Data mining? Check for data mining: - Does it make economic sense?- Does it still hold in other countries or periods? (out-of-sample test)- Does it hold in sub-samples?(4) Small sample bias?Does the mispricing continue to hold in longer sample period? (5) Selection biasThe sample may be biased in favor of finding mispricing.e.g. 1. Survivorship bias in mutual fund studiese.g. 2.Losers bias only losers are willing to reveal their investment strategies that do not workFama and French three-factor model (1996)Fama and French started with the observation that two classes of stocks have tended to do better than the market as a whole: (i) small caps and (ii) stocks with a high book-to-price ratio (value stocks). They then added two factors to CAPM to reflect a portfolios exposure to these two classes. FF found that a combination of beta, size, and value explained 95% of a diversified portfolios return. 25 well-diversified portfolios of US stocks are formed based on size and book-to-price ratio.The following 3-factor model is estimated for each of the 25 portfoliosRP,t RF,t= aP + bMMF RMMF,t + bSMB RSMB,t + bHML RHML,t + etThe three factors are as follows:Market index R MMF,t = R M,t RF,tSize factorR SML,t = Rsmall cap,t Rlarge cap, tBook-to-PriceR HML,t = R high B/P,t Rlow B/P,t value growthFactor beta estimates in Fama and French (1996)PortfolioSizeB/PaPbMMFbSMLbHML1SmallLow-0.451.031.47-0.272Small2-0.161.011.270.103Small3-0.050.941.180.254Small40.040.891.170.375SmallHigh0.020.941.230.6362Low-0.071.101.01-0.49722-0.041.040.970.008230.090.990.880.269240.070.970.730.46102High0.031.080.900.69113Low-0.081.100.75-0.3912320.041.020.630.0313330.000.980.590.3214340.060.970.470.49153High0.071.070.640.68164Low0.141.070.36-0.441742-0.191.070.300.031843-0.061.050.290.3119440.021.030.220.54204High0.061.180.410.7221LargeLow0.20.96-0.16-0.4722Large2-0.041.02-0.130.0023Large3-0.10.98-0.250.2024Large4-0.080.99-0.160.5625LargeHigh-0.141.07-0.030.82Source: Fama and French (1996), Table I. Key points:1. Besides the market index, size and book-to-market ratios are statistically significant factor of stock returns.2. The 3 factors together can explain 81 to 96% of stock returns variation.3. Note how the factor betas change as you vary sizeSmall cap portfolios (no.1 - 5) have positive bSMLLarge cap portfolios (no.21 - 25) have negative bSML4. For B/P factor, growth stocks (with low B/P ratio) generally have negative factor betas.Interpretation1) For those who do not believe in EHM, this is an indication of abnormal return. 2) For those who believe in EMH, SMB and HML capture the risk premium demanded by investors from risk factors that are not captured by the market index and embedded in SMB and HML. Hence, * stocks with a lower P/B must be more risky than average. * stocks with a small market cap must be more risky than average. i.e. What are these risk factors? c) Behavioral bias: Investors over-reaction Investors are too pessimistic about value stocks (have weak fundamentals). This causes underpricing of distressed stocks and hence their high returns. On the contrary, investors are overly optimistic on growth stock. This causes overpricing of growth stocks and hence their low returns. When these overreactions are corrected, value stocks beat growth stocks. Since this is a behavioral bias it will not go away.e) Agency problemAnother behavioral explanation fro higher return of distressed stocks is that some fund managers find