Reading 38: Market Efficiency
General Concepts
Informational Efficient
Security prices reflect all available information fully, quickly and rationally.
The more efficient the market, the quicker its reaction to new information.
Only unexpected information would elicit trader's response.
Fully efficient market
Active investment strategies cannot earn the positive risk-adjusted return consistently.
Thus, investors should therefore use a passive strategy.
Market value vs. Intrinsic value
Market value
Intrinsic value
Factors affecting market efficiency
Make market more efficient
Make market less efficient
Market efficiency forms
Weak-form
MAIN
Semi-strong-form
Strong-form
Market Anomalies
Security price fully reflect all information about past price and volume
Technical analysis does not consistently result in abnormal profits
Security price fully reflect all publicity available information
Fundamental analysis does not consistently result in abnormal profit; however they are necessary if market prices are to be semi-strong-form efficient.
Security price fully reflect all private and public information
Active investment management does not consistently result in abnormal profit.
Roles for Portfolio Managers
Investors CANNOT use information to earn positive abnormal (risk-adjusted) return on average
The price that investors with full knowledge of asset characteristics would place on the asset.
Price at which it can be bought or sold
If markets are not efficient, market values will differ from intrinsic value in predictable ways
Larger numbers of market participants
Greater information availability
Impediment to arbitrage, short-selling
High costs of trading & gathering information
Establish portfolio risk/return objectives
Portfolio diversification
Implement asset allocation based on risk/return objectives
Tax minimization
Anomalies are observed market inefficiencies - evidence of predictable risk-adjusted returns
Anomalies by research method:
Time series anomalies
Cross-sectional
Other
Calendar effects: January (tax-loss selling, window dressing), turn-of-month, day-of-week, weekend, holiday
Overreaction: Prices inflated after good news, depressed after bad news - losers beat winners
Momentum: High short-term returns continue in following periods - may be rational reaction
Size effect: Small-cap stocks outperform large-cap stocks - sensitive to time period
Value effect: Low P/E, low P/B, high dividend yield stock outperform - disappears with Fama and French model
slow adjustment to earnings surprises
IPOs: Initial overreaction, long-term underperformance
Anomaly Evidence
Most evidence appears to result from methodology used
Many anomalies are not profitable when transactions costs are considered
Some strategies have ceased to work overtime
Some strategies only work in some time periods
Portfolio management should not be based on anomalies with no economic basis
Behavior finance
Investors behave in ways that are not rational
Investors have cognitive biases
Loss aversion
Risk aversion is asymmetrical
Investors dislike losses more than they like gains
Overconfidence
Investors overestimate their ability to value securities
Gambler's fallacy
Recent results affect estimates of future probabilities (don't wanna quit while on a streak)
Information cascades
Uninformed investors mimic actions of informed investors
Investor irrationality due to cognitive bias does NOT necessarily mean that rational investor can "beat the market"
Market can still be efficient despite of irrationality in some investors
Market Inefficiency: Ngược lại của Efficient tại từng mức độ