Efficient Market Hypothesis CHAPTER 9

What are we going to learn in this chaper?

If you knew Koza Altın’s stock price is going to jump from 30 TL to 40 TL in 3 days what would you do?

If all the investors knew Koza Altın’s stock price is going to jump from 30 TL to 40 TL in 3 days what would they do?

Random Walk Prediction with great confidence Immediate buy orders Noone willing to sell Immediate price jump

Random Walk Predicted jump being reflected immediately Information reflection into prices Underpriced stock New information Unpredictable news

Random Walk Random walk Rational investors Competing investors Importance of new information Efficient market hypothesis (EMH)

Efficiency: Illustrations Response of stock prices to new information in an efficient market. (takeover announcement, premium, public announcement) Stock prices following CNBC’s Morning segment mentioning

Efficiency: Illustrations

Versions of EMH Weak-form efficiency Semistrong-form efficiency Strong-form efficiency

Technical Analysis Technical analysis Search for recurrent and predictable patterns in stock prices Does technical analysis contradict EMH?

Technical Analysis Opportunity of exploiting to make a profit Relative strength approach Resistance levels Support levels Example of resistance level

Technical Analysis The efficient market hypothesis implies that technical analysis is without merit Reflection into stock prices Abnormal returns and expectations about them Example: the market believes that a level of TL 8 truly is a resistance level for Mardin çimento stocks

Technical Analysis Will a technical rule that seems to work will continue to work in the future once it becomes widel recognized? Does the rule itself becomes reflected in stock prices once its value is discovered? Self-destructing patterns Yet-undiscovered rules

Fundamental Analysis What’s Fundamental Analysis? Which information does fundamental analysis use? Comparison of implied and current prices Does the fundamental analysis contradict EMH? An attempt to find firms that are better than everyone else’s estimate

Active vs. Passive Portfolio Management Let’s assume you have 10,000 TL and find an opportunity to earn extra 1 %. How good is this? Amy Lucas who runs a portfolio of 10 billion $ finds an opportunity to earn extra 1 %. How good is this? Costs? Is watching CNBCE going to help you become rich?

Active vs. Passive Portfolio Management If small investors are not in a favored position to conduct active portfolio management, what are their choices? Mutual funds and their benefits Can investors be sure that even large mutual funds have the ability or resources to uncover mispriced stocks?

Active vs. Passive Portfolio Management Would the proponent of EMH suggest active portfolio management? Passive strategty and buy-and-hold returns Index Fund

Active vs. Passive Portfolio Management

Portfolio Management under EMH If the market is efficient, why not pick stocks by throwing darts at Borsa Istanbul? Why bother trying to diversify? Which stocks should a Toyota executive whose annual bonus depends on Toyota’s profits generally not invest additional amounts in? Would you invest in the same portfolio assets right now as you would when you are 67 years old?

Portfolio Management under EMH Investors of varying ages also might warrant different portfolio policies with regard to risk bearing. For example, older investors who are essentially living off savings might choose to avoid long-term bonds whose market values fluctuate dramatically with changes in interest rates (discussed in Part Four). Because these investors are living off accumulated savings, they require conservation of principal. In contrast, younger investors might be more inclined toward long-term inflation-indexed bonds. The steady flow of real income over long periods of time that is locked in with these bonds can be more important than preservation of principal to those with long life expectancies. In conclusion, there is a role for portfolio management even in an efficient market. Investors’ optimal positions will vary according to factors such as age, tax bracket, risk aversion, and employment.

How could you test whether markets are efficient or not?

Event Studies Event study (dividend changes) Ought to be return Abnormal return

Event Studies Benchmarks Asset pricing models Leakage of information Cumulative abnormal returns

Weak-form Efficiency Tests Returns over Short Horizons (Serial correlation) (Positive serial correlation) (Negative serial correlation) Returns over Long Horizons

Semistrong-form Efficiency Tests Market anomalies Risk adjustment and CAPM Size effect January effect

Semistrong-form Efficiency Tests Neglected firm effect Liquidity effect Book-to-market ratio anomaly Post-earnings announcement drift

Size Effect

Book-to-Market Effect

Post-earnings Announcement Drift

Strong Form Efficiency Tests Who are insiders? Can they benefit in anyway? Why does noone regulate them?

END OF CHAPTER