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Summary of Notes on Empirical Evidence on Efficient Market Hypothesis
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The Efficient Market Hypothesis and its Critics (Burton G. Malkiel, 2002)- For discussion questions, identify the theory, findings and conclusions, also
recognise the assumptions/different perspectives with evidence
- List out the theories that can be combined: E.g. for EMH can combine
systematic risk: Research the specific forms and assumptions
Conclusion
- Collective judgement of investors is not foolproof; some investors much less rational
than others
- Results in pricing irregularities and price patterns; perfect efficiency cannot exist or
would be no incentive to identify info incorporated so fast into the price
- Patterns/pricing inconsistencies unlikely to generate abnormal returns
Research Questions:
Challenges of the Efficient Market Hypothesis
Relationship between Predictability and Market Efficiency
Predictable Price Patterns: Based on Firm Characteristics and Valuation Parameters:
The Size Effect: smaller company stocks found to generate larger returns than those of
large company stocks; size effect could indicate market inefficiency, suing beta as a
proxy
But F+F found size is a much better predictor than beta
Value Stocks:
Value Stocks have higher returns than Growth Stocks
Stocks with low P/E ratios (value stocks) have higher rates of return than growth
stocks; but investors overinvest in growth stocks
Equity Risk Premium
Existence of Large Historical Equity Risk Premium: any high average returns were
result of large, unexpected capital gains
Tests of Market Efficiency:
- Performance of Professional Investors: if there is opportunity to earn abnormal
returns, fund managers should be able to spot patterns in securities and use them to
beat the market based on market prices determined by irrational investors
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