FINC 335 Investments: The Efficient Market Hypothesis TOPIC 8

These flashcards summarize key concepts from the Efficient Market Hypothesis lecture, covering market efficiency, CAPM, price reactions, and common misconceptions.

What does the Efficient Market Hypothesis (EMH) state about market prices?

Market prices fully reflect all available information.

What are the three forms of market efficiency according to EMH?

Weak, Semi-strong, and Strong form efficiency.

What does Weak Form Efficiency imply about past prices?

Prices reflect all information contained in the history of past prices.

What does the Random Walk Hypothesis suggest about stock prices?

Stock prices change randomly and are unpredictable, as they always reflect fundamental value.

What is an implication of market efficiency regarding price reactions?

Prices should react quickly and accurately to new information.

What does it mean when we say stock prices change randomly?

Price changes should be random and unpredictable.

What does Semi-strong Form Efficiency indicate about publicly available information?

Prices reflect all publicly available information.

What is the momentum effect in the context of Weak Form Efficiency?

Poorly performing stocks and well-performing stocks tend to continue their abnormal performance in subsequent periods.

What anomaly contradicts Semi-strong Form Efficiency regarding stock returns?

The Small-Firm-in-January Effect.

What is the key misconception about the efficiency of markets?

Efficiency does not imply that market prices are socially desirable.

How does market efficiency relate to stock returns following good news?

Stock prices may not rise upon good news if it is less favorable than expected.

What is a significant insight about the performance of investment managers?

Most investment managers do not consistently outperform the market.

What is a common misconception regarding market outperforming?

Efficiency does not mean that no one can outperform the market consistently.

What is the tendency of stock prices in response to news reports?

They react quickly within minutes to both favorable and unfavorable news.

What is an example of Semi-strong efficiency in action?

Stock prices reacting to earnings announcements, credit rating changes, and other public information.

What does Strong Form Efficiency claim about information incorporation?

Prices fully reflect all available information, both public and private.

What is an example of evidence against Strong Form Efficiency?

Corporate insiders can earn abnormal returns.

What does the term 'arbitrage' refer to in this context?

The practice of taking advantage of price differences in different markets.

What is a limitation of arbitrage that questions market efficiency?

Arbitrage involves considerable risks and can fail to correct mispricings.

What conclusion can be drawn about the systematic ability to outperform the market?

It is difficult for market participants to beat the market consistently on a risk-adjusted basis.

What historical data analysis supports Weak Form Efficiency?

Empirical evidence suggests stock prices tend to follow a random walk.

What does the term 'anomaly' refer to in market efficiency?

Instances where market behavior deviates from what EMH would predict.

What empirical evidence suggests against the efficiency of markets?

The existence of market anomalies that persist over time.

What are two types of price movements observed in Weak Form Efficiency?

The Momentum Effect and the Reversal Effect.

What is the implication of EMH for securities analysis?

Securities analysts may question their utility if markets are efficient.