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Market Efficiency and a few topics in Behavioral Finance Fin 3504
From the Chapter 8 power point slides
Terms in this set (22)
A forecast about favorable future performance leads instead to favorable current performance, as market participants all try to get in on the action before the price jump.
If prices are bid immediately to fair levels, given all available information, it must be that they increase or decrease only in response to new info.
"new" info by definition, must be unpredictable
Stock prices should follow a "random walk"
The notion that stocks already reflect all available information is referred to as the _______
Efficient market hypothesis
What are the 3 versions of the Efficient Market Hypothesis
Stock prices already reflect all information that can be derived by examining market trading data such as the history of past prices, trading volume, or short interest describes which verion of the EMH
This form of EMH states, all publicly available info regarding the prospects of a firm must be reflected already in the stock price. (in addition to past prices, fundamental data on the firm's product line, quality of management, balance sheet composition, patents held, earning forecasts, and accounting practices)
This form of EMH states, stock prices reflect ALL information relevant to the firm (including information available only to company insiders)
________ usually start with a study of past earnings and an examination of company balance sheets. They supplement this analysis with further detailed economic analysis, ordinarily including an evaluation of the quality of the firm's management, the firm's standing within its industry, and the prospects for the industry as a whole
The _____ predicts that only analysts with superior insight will be rewarded.
Efficient market hypothesis (EMH)
________ calls for the selection of a well-diversified portfolio providing the systematic risk level that the investor wants
Rational security selection
_______ also requires that tax consequences be considered. High bracket investors might want to tilt their portfolios in the direction of capital gains as opposed to dividend or interest income
Rational investment policy
The role of the __________ in an efficient market is to tailor the portfolio to these needs, rather than to beat the market
This is an example of the _________ issue.
-consider an investment manager overseeing a $2 billion portfolio
-if she can improve performance by only 1/10th of 1 percent per year, that effort will be worth .001 x $2 billion = $2 million annually.
-this manager clearly would be worth her salary! Yet can we, as observers, statistically measure her contribution?
-Probably not: a 1/10th of 1 percent contribution would be swamped by the yearly volatility of the market
The Magnitude Issue
Only investors who find that an investment scheme cannot generate abnormal returns will be willing to report their finding to the whole world describes which market efficiency issue.
The Selection Bias Issue
The ________ Issue states:
- If many investors using a variety of schemes make fair bets, statistically speaking, some of those investors will be lucky and win a great majority of the bets.
- The winners, though, turn up in The Wall Street Journal as the latest stock market gurus; then they can make a fortune publishing market newsletters
The Lucky Event Issue
________ shows that the return on the aggregate stock market tends to be higher when the dividend/price ratio, the dividend yield, is high
Fama and French
________ find that the earnings yield can predict market returns
Campbell and Shiller
Tests of the risk- adjusted returns are ______ of the effiecient market hypothesis and the risk adjustment procedure.
A serious error in judgment you can make as an investor is to be ________
Barber and Odean show that both men and women ______ their portfolio returns when they trade excessively
Las Vegas casinos have found that gamblers are far more likely to take big risks with money that they have won from the casino.
The House Money Effect, 1
This is an example of what?
-suppose you bough ABC for $45 and it is currently selling for $40 and you bought XYZ for $10 and it is currently selling for $40.
-suppose shares in both were to decline depending on which stock you looked at.
-with ABC, the decline makes a bad situation even worse. Now you are down $30/share on your investment
-On the other hand, with XYZ, you only "give back" some of your "paper profit." You are still way ahead.
The House Money Effect, 2
Lesson one: There are no "paper profits." Your profits are yours.
Lesson two: All your money is your money. You should not separate your money into bundles labeled "my money" and "house money"
Lessons of the House Money Effect
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