1. Market efficiency Kevin C.H. Chiang

2. Efficient market (Informationally) efficient market: a market in which security prices adjust fully and rapidly to the arrival of new information and, therefore, the current prices of securities fully reflect all available information about the security.

3. 3 sufficient conditions for an efficient market (Fama) A large number of competing profit- maximizing participants analyze and value securities, each “independent” of the others. New information comes in a “random” fashion. The competing investors attempt to adjust security prices rapidly to reflect the effect of new information.

4. 3 forms of market efficiency, I Weak form: prices reflect all information contained in the history of past trading. Question: do past returns and prices predict future returns?

5. 3 forms of market efficiency, II Semi-strong form: prices reflect all publicly available information (earnings, dividends, PE ratios, book-to-market ratios, political news, etc.) Question: how quickly do prices reflect all public information?

6. 3 forms of market efficiency, III Strong form: prices reflect all relevant information, including inside information. Question: Do insiders make abnormal returns?

7. Testing Does a known strategy produce consistently abnormal returns after adjusting for investment risk and transaction costs? No: the market is quite efficient. Yes: evidence against the EMH.

8. Implications, I In an efficient market, technical analysis is useless. In a semi-strong form efficient market, fundamental analysts (country analysts, industry analysts, and company analysts), on average, will not outperform the market.

9. Implications, II In a semi-strong form efficient market, fundamental analysis is useless. In this market, a portfolio manager should: (1) determine a proper level of risk tolerance, (2) form a portfolio consisting of the risk-free asset and a well-diversified risky portfolio (passive management), and (3) minimize taxes and total transaction costs.

10. Passive management No attempt to find undervalued securities. No attempt to time. Hold a well-diversified portfolio.

11. Active management/selection Believe that one can beat the market. Find undervalued securities. Time the market.