1. Lecture 10 Efficient Markets
Managerial Finance
FINA 6335
Ronald F. Singer

2. Efficient Markets
Perfect
Capital
Markets
Efficient
Markets.
Versus

3. Forms of Market Efficiency
Weak form:
Semi-strong form:
Strong form:

4. Efficient Markets
In general we can say markets are "efficient" with respect to some information set f if:
Expectations regarding the future price of the stock given the information contained in f is equal to the expected price given the current price.
Beware of expecting too much from market efficiency arguments: "Anomalies"

5. Why Should Markets Not be Efficient?
1- The speed at which information is "disseminated" to the market
2- Investors Overreact
Price
Time
INF

6. Why Should Markets Be Efficient?
Price
6.50
5.50
5.00
Time

7. The Evidence
Weak Form:
Definition:
Methodology: Filter Rules

8. Weak Form Price Change position when stock price changes by x%.
2. Compare with buy and hold
Abnormal positive or negative
returns imply weak form inefficiency.
Time
t-1 t

9. Weak Form
Results 
Filter rule results in statistically significant abnormal returns for filters less than 1 1/2%
1 1/2% Filter Buy and Hold
11.52% Annual Yield %
12, Number of Trades
% Floor Traders' Return after Transaction Costs:

10. Semi-Strong Form Definition: Methodology: "Event Studies"
1. Define Information
2. Define Abnormal returns
Models of "normal returns"
Rit = αi + ßi Rmt + εit Market Model
Rit = Rft + ßi(Rmt - Rft) + εit CAPM
If εit ╪ 0; There are abnormal returns

11. Semi-Strong Form Test Procedure FAMA, FISHER, JENSEN, ROLL(1969)
A. Identify Firms "Announcing" Event
B. Calculate Average residuals, cumulative Average residuals around the "Event Date"
Example
Company Announcement(t=0) t= -1
ABC 9/25/80 9/24/80
DEC 8/7/ /6/79
IBM 8/3/ /2/79
Then we have εit i=1, ...,N, t = ,0,...30

12. Patterns Average Cumulative Abnormal Abnormal Average Residual
ARt = Σ 1 εit
i=1 N T
CART = Σ ARt
t= -30
  Results:
-30 30
-30 30

13. Strong Form Market Efficiency
Definition:
Methodology:
Compare trades made by "insiders" to a buy and hold strategy
Result:

14. Anomalies 1. Value Line 2. Weekend Effect 3. Year End Effect
4. Price Earnings Ratio
5. Small Firm
6. Insiders Trading
7.The October Stock Market Crashes
8. Post Announcement Drift.