Efficient Markets - Financial Markets - Lecture Slides, Slides of Marketing

Download Efficient Markets - Financial Markets - Lecture Slides and more Slides Marketing in PDF only on Docsity! Efficient Markets and Excess Volatility docsity.com The Efficient Markets Hypothesis • History of the Hypothesis • Reasons to think markets are efficient • Reasons to doubt markets are efficient • Technical analysis • Empirical evidence in literature • Homework assignment and regressions docsity.com Textbook Version Today As one of the six most important ideas in finance: “Security prices accurately reflect available information, and respond rapidly to new information as soon as it becomes available” Richard Brealey & Stewart Myers, Principles of Corporate Finance, 1996 docsity.com Harry Roberts, 1967 • Weak form efficiency: prices incorporate information about past prices • Semi-strong form: incorporate all publicly available information • Strong form: all information, including inside information docsity.com Price as PDV of Expected Dividends • If earnings equal dividends and if dividends grow at long-run rate g, then by growing consol model P=E/(r-g), P/E=1/(r-g). (Gordon Model) • So, efficient markets theory purports to explain why P/E varies across stocks • PEG ratio is popular indicator = g’/(P/E), where g’ is short-run growth rate; popular rule of thumb: buy if PEG<0.5 • PEG rule of thumb makes sense only if g’ bears a certain relation to g; not a sensible rule. • Efficient markets denies that any rule works docsity.com Psychological Factors • Gambling behavior • Overconfidence • Slowness to make money, futility of career trying to prove others of one’s ability • Siegel and Peter Lynch docsity.com Popular Doubters of Efficiency • Peter Lynch: Elementary school children beat professionals • Beardstown Ladies • Robert Kiyosaki Rich Dad, Poor Dad • Motley Fool docsity.com Raskob on the Market “Suppose a man marries at the age of twenty-three and begins a regular saving of fifteen dollars a month – almost anyone who is employed can do that if he tries. If he invests in good common stocks and allows the dividends to accumulate, he will have at the end of twenty years at least eighty thousand dollars. . .I am firm in my belief that anyone not only can be rich but ought to be rich.” John J. Raskob, Ladies Home Journal, 1929 docsity.com Head & Shoulders Pattern • Initial advance attracts traders, upward momentum. Smart money begins to distribute stock, trying not to kill demand. • Eventually downturn, but smart money comes in to support demand, manipulation. (left shoulder) • Upward momentum resumes, ends when smart money has distributed all shares; market drops. • New traders try to exploit well-known tendency to rally. New weak rally, right shoulder, then a breakout. (Edwards & Magee) docsity.com Random Walk Hypothesis • Karl Pearson, Nature, 72:294, July 27, 1905. Aug 10, 1905, walk of drunk • Burton Malkiel, A Random Walk Down Wall Street, 1973. docsity.com Random Walk & AR-1 Models • Random Walk: xt=xt-1+t • First-order autoregressive (AR-1) Model: xt=100+(xt-1-100)+t. Mean reverting (to 100), 0< <1. • Random walk as approximate implication of unpredictability of returns • Similarity of both random walk and AR-1 to actual stock prices docsity.com Tulipmania • Holland, 1630s. • Peter Garber, Famous First Bubbles • Mosaic virus, random-walk look • Free press began in Holland then. docsity.com Dot Com Bubble • Toys.com: Had disadvantage relative to bricks & mortar retailers starting web sites • Lastminute.com: travel agency, sales in fourth quarter of 1999 were $650,000, market value in IPO ins March 2000 was $1 billion. docsity.com Problem Set #3: Forecast the Market • Step 1: Get stock price data on spreadsheet, as from yahoo.com. • Step 2: Create new column showing percentage price changes • Step 3: Create new Column(s) containing forecasting variables • Step 4: Test for significance and interpret results. docsity.com