Chapter 8 The efficient market hypothesis

EMH (efficient market hypothesis)

prices of security fully reflect available market information

• meaning its impossible to outperform the market by purchasing undervalued stocks or selling stocks at inflated price

• best investment strategy is low-cost, passive portfolio

random walk

notion that stock price changes are random

weak from EMH

Stock prices already reflect all
information contained in history of trading

semistrong-form EMH

Stock prices already reflect all public information

-passive management consistent

strong form EMH

Stock prices already reflect all
relevant information, including inside information

resistance level

unliekly for stock/index to rise above

support level

unlikely for stock/index to fall below

fundamental analysis

Research on determinants of stock value:
• Earnings, dividend prospects, future interest rate
expectations and firm risk
• Assumes stock price equal to discounted value of expected
future cash flow

index fund

Mutual fund which holds shares in proportion to market
index representation

momentum effect

Tendency of poorly- or well-performing stocks to continue abnormal performance in following periods

reversal effect

(run over long horizons)

Tendency of poorly- or well-performing
stocks to experience reversals in following periods

anomalies

Patterns of returns that seem to contradict the efficient market hypothesis

P/E effect

Portfolios of low P/E stocks have exhibited higher average risk adjusted returns that high P/E stocks