capital market, (2013-2), jra.pdf

8/14/2019 Capital Market, (2013-2), JRA.pdf

1/9

1

Frequency of Returns on Ordinary

Shares 19782002

11/6/2013 4311/6/2013 Jorge Ramrez Arroyo 43

The Normal Distribution

15.50% + 37.55% = 53.05%15.50% + 2(37.55%) = 15.50+75.10= 90.60%

15.50% + 3(37.55%) = 15.50+112.65= 128.15%



2/9

2

Capital Market Efficiency The informationally efficient market hypothesis (EMH) asserts that the

price of a security accurately reflects all available information.

In perfect information capital markets:

Market value = Intrinsic value (Fundamental value)

Implies also that all securities are fairly priced,

making it impossible to buy undervalued stocks or sell stocks forexaggerated prices.

Implies that all investments have a zero NPV.

If this is true then investors cannot earn abnormal or excess returns.

Use passive investment strategy, instead active strategy

Only unexpected information impacts stock prices

One measure of efficiency is time lag from information dissemination tochange in security price.


D

S

p

0 +t-tAnnouncement date

What Makes Markets Efficient?

There are many investors out there doing research:

- As new information comes into the market, this information isanalyzed and trades are made based on this information.

- Therefore, prices should reflect all available public information.

If investors stop researching stocks, then the market will not beefficient.

Number of Participants

Availability of Information

Limits of Trade Operational efficiency Short Selling

Arbitrage

Transaction Costs

Information Costs



3/9

3

Common misconceptions about EMH Efficient markets do not mean that you cant make money.

They do mean that, on average, you will earn a return that is appropriatefor the risk undertaken and that there is not a bias in prices that can beexploited to earn excess returns.

Market efficiency will not protect you from making the wrong choices if

you do not diversifyyou still dont want to put all your eggs in onebasket


0

0

Sets of Information relevant to astock

1. Past prices

2. Publicly availableinformation

3. All information


3 Types of information:

Market data or securitydata information (1)(volume, prices, etc..)

Public information (2)(political, social,information..)

Non public or privateinformation (3).


4/9

4

Forms of Market Efficiency

Weak form efficiency: Current prices reflect informationcontained in the past series of prices and are random walk.

Semi-strong form efficiency: Current prices reflect all publiclyavailable information. (Average efficiency)

Strong form efficiency: Current prices reflect all information ofevery kind.


Price Behavior in Efficient and

Inefficient Markets

Efficient market reaction: The price instantaneously adjusts toand fully reflects new information. There is no tendency forsubsequent increases and decreases.

Delayed reaction: The price partially adjusts to the newinformation. Several days elapse before the price completelyreflects the new information.

Overreaction: The price over-adjusts to the new information. Itovershoots the new price and subsequently corrects itself.

Headline Effect - The effect that negative news in the popular

press has on a corporation or an economy. Whether it is justifiedor not, the investing public's reaction to various headlines can bevery dramatic. Many economists believe that negative newsheadlines make consumers more reluctant to spend money



5/9

5

Reaction of Stock Price to NewInformation in Efficient and Inefficient

Markets

StockPrice

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

Days before (-) and after (+) announcement

Efficient market responseto good news

Overreaction to goodnews with reversion

Delayedresponse to

good news


52

Technical Analysis - Using prices and volume information, it tryto predict future price movements

Weak form of efficiency & technical analysis

Fundamental Analysis - Using economic and accountinginformation, it try to predict the future prices of the securities

Semi-strong form efficiency & fundamental analysis

Securities Analysis


6/9

6

Implications of EMH for Corporate

Financial Managers Active management

Asset analysis

Timing (opportunity in buying and selling)

Passive management

Buy and hold

Index funds

Can financial managers fool investors?

Can financial managers time security sales?

Are there price pressure effects?

http://www.youtube.com/watch?v=t7GoDcVYnjM


Some anomalies

M o n d a y e f f e c t s - A theory that states that returns on Mondayswill followthe prevailing trend from the previous Friday. Some studies have shown apositive correlation, but no one theory has been able to accurately explainthe existence of the Monday effect.

W e e k e n d e f f e c t s - A phenomenon in which stock returns on Mondaysare often significantly lower than those on the preceding Friday. Sometheories explain the tendency for companies to release bad news onFriday after the markets close to depressed stock prices on Monday.Others state that the effect might be linked to short selling, which wouldaffect stocks with high short interest positions. Alternatively, the effectcould simply be a result of traders' fading optimism between Friday and

Monday. According to a study by the Fed, prior to 1987 there was astatistically significant negative return over the weekends. However, thestudy states that this negative return had disappeared in the period frompost-1987 to 1998. Since 1998, volatility over the weekends has increasedagain, and the phenomenon remains a much debated topic.



7/9

7

Some anomalies J a n u a r y e f f e c t s - A general increase in stock prices during the month of

January. This rally is generally attributed to an increase in buying, whichfollows the drop in price that typically happens in December wheninvestors, seeking to create tax losses to offset capital gains, prompt asell-off. Is said to affect small caps more than mid or large caps. Thishistorical trend, however, has been less pronounced in recent yearsbecause the markets have adjusted for it.

S m a l l f i r m e f f e c t s - One of the biggest advantages of investing in small-cap stocks is the opportunity to beat institutional investors. Becausemutual funds have restrictions that limit them from buying large portionsof any one issuer's outstanding shares, some mutual funds would not beable to give the small cap a meaningful position in the fund.

P r e a c q u i s i t i o n r u n - u p s (to make or become greater or larger: run upthe price of the company's stock).


S t o c k M a r k e t C r a s h , is a sudden dramatic decline of stock pricesacross a significant cross-section of a stock market, resulting in asignificant loss of paper wealth. Crashes are driven by panic as much asby underlying economic factors. They often follow speculative stockmarket bubbles.

Stock market crashes are social phenomena where external economicevents combine with crowd behavior and psychology in a positivefeedback loop where selling by some market participants drives moremarket participants to sell. Generally speaking, crashes usually occurunder the following conditions: A prolonged period of rising stock pricesand excessive economic optimism, a market where P/E ratios exceed

long-term averages, and extensive use of margin debt and leverage bymarket participants.

11/6/2013 Jorge Ramrez Arroyo 56

Some anomalies


8/9

8

Some more explanations

Calendar Effect - A collection of assorted theories that assertthat certain days, months or times of year are subject toabove-average price changes in market. Some theories thatfall under the calendar effect include the Monday effect, theOctober effect, the Halloween effect and the January effect.

Closing positions over the weekend.

Ditto (the same as stated above or before).

Tax timing, annual reporting, data mining.

Trading with better informed quasi-insiders.

Information leaking out bit by bit.


Behavioral Finance

A field of finance that proposes psychology-based theories to explainstock market anomalies. Within behavioral finance, it is assumed thattheinformation structure and the characteristics of market participantssystematically influence individuals' investment decisions as well asmarket outcomes.

There have been many studies that have documented long-termhistorical phenomena in securities markets that contradict the efficientmarket hypothesis and cannot be captured plausibly in models basedon perfect investor rationality. Behavioral finance attempts to fill thevoid.

Professor Shiller. YaleCourses, Behavioral Finance and the Role ofPsychology. Published on 05/04/2012. Financial Markets (2011) (ECON252). http://www.youtube.com/watch?v=chSHqogx2CI



9/9

9

Adaptive Market Hypothesis A theory posited in 2004 by MIT professor Andrew Lo. It attempts to

marry the rational, and often controversial, Efficient Market Hypothesisprinciples with the irrational behavioral finance principles.

Lo postulates that investor behaviors such as loss aversion,overconfidence and overreaction are consistent with evolutionary modelsof human behavior, which include actions such as competition,adaptation and natural selection.

The theory states that humans make best guesses based on trial anderror. For example, if an investor's strategy fails, he or she is likely to trya different strategy. If the strategy is successful, however, the investor islikely to try it again.

Applies the principles of evolution and behavior to financial interactions.

Efficient Market Hypothesis states that it is not possible to "beat themarket" because stocks always trade at their fair value, making itimpossible to buy undervalued stocks or sell stocks for exaggeratedprices. Behavioral finance attempts to explain stock market anomaliesthrough psychology-based theories.


capital market, (2013-2), jra.pdf

Documents