Efficient Market Hypothesis
Chapter 13
Efficient Market Hypothesis
Road Map
Part A Introduction to Finance.
Part B Valuation of assets, given discount rates.
Part C Determination of discount rates.
Part D Introduction to corporate finance.
• Efficient Market Hypothesis (EMH).
• Capital investment decisions (capital budgeting).
• Financing decisions.
Main Issues
• Efficient Market Hypothesis (EMH)
• Empirical evidence on EMH
• Implications of EMH
• Questions and practical issues about EMH
13-2 Efficient Market Hypothesis Chapter 13
Contents
1 EfficientMarket Hypothesis (EMH) . . . . . . . . . . . . . . 13-3
2 Empirical Tests of EMH . . . . . . . . . . . . . . . . . . . . 13-6
2.1 Supportive Evidence of EMH . . . . . . . . . . . . . . . . . . . . 13-7
2.2 Negative Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . 13-12
3 Implications of EMH . . . . . . . . . . . . . . . . . . . . . . 13-14
4 Questions about EMH . . . . . . . . . . . . . . . . . . . . . 13-15
5 Practical Issues about EMH . . . . . . . . . . . . . . . . . . 13-16
6 Homework . . . . . . . . . . . . . . . . . . . . . . . . . . . 13-17
15.407 Lecture Notes Fall 2003 _c Jiang Wang
Chapter 13 Efficient Market Hypothesis 13-3
1 Efficient Market Hypothesis (EMH)
In an efficient financial market, an asset’s price should be the best possible estimate of its economic values.
Definition: A financial market is (informationally) efficient when market prices reflect all available information about value.
A precise definition needs to answer two questions:
1. What is “all available information”?
2. What does it mean to “reflect all available information”?
Different answers to these questions give rise to different versions of market efficiency.
_c Jiang Wang Fall 2003 15.407 Lecture Notes
13-4 Efficient Market Hypothesis Chapter 13
Intuitive answers to these two questions:
1. All available information includes:
(a) Past prices – Weak form.
(b) All public information – Semi-Strong Form.
-
Efficient Market Hypothesis
Road Map
Part A Introduction to Finance.
Part B Valuation of assets, given discount rates.
Part C Determination of discount rates.
Part D Introduction to corporate finance.
• Efficient Market Hypothesis (EMH).
• Capital investment decisions (capital budgeting).
• Financing decisions.
Main Issues
• Efficient Market Hypothesis (EMH)
• Empirical evidence on EMH
• Implications of EMH
• Questions and practical issues about EMH
13-2 Efficient Market Hypothesis Chapter 13
Contents
1 EfficientMarket Hypothesis (EMH) . . . . . . . . . . . . . . 13-3
2 Empirical Tests of EMH . . . . . . . . . . . . . . . . . . . . 13-6
2.1 Supportive Evidence of EMH . . . . . . . . . . . . . . . . . . . . 13-7
2.2 Negative Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . 13-12
3 Implications of EMH . . . . . . . . . . . . . . . . . . . . . . 13-14
4 Questions about EMH . . . . . . . . . . . . . . . . . . . . . 13-15
5 Practical Issues about EMH . . . . . . . . . . . . . . . . . . 13-16
6 Homework . . . . . . . . . . . . . . . . . . . . . . . . . . . 13-17
15.407 Lecture Notes Fall 2003 _c Jiang Wang
Chapter 13 Efficient Market Hypothesis 13-3
1 Efficient Market Hypothesis (EMH)
In an efficient financial market, an asset’s price should be the best possible estimate of its economic values.
Definition: A financial market is (informationally) efficient when market prices reflect all available information about value.
A precise definition needs to answer two questions:
1. What is “all available information”?
2. What does it mean to “reflect all available information”?
Different answers to these questions give rise to different versions of market efficiency.
_c Jiang Wang Fall 2003 15.407 Lecture Notes
13-4 Efficient Market Hypothesis Chapter 13
Intuitive answers to these two questions:
1. All available information includes:
(a) Past prices – Weak form.
(b) All public information – Semi-Strong Form.
-