第十九屆亞太財務經濟會計及管理會議 The Efficient Markets Hypothesis The Demise of the Demon of Chance? Stephen J. Brown NYU Stern School of Business The 19th Annual Conference on Pacific Basin Finance, Economics, Accounting, and Management

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory  Asset pricing theory

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory  Asset pricing theory  Efficient Markets Hypothesis

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory  Asset pricing theory  Efficient Markets Hypothesis  Corporate finance

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory  Asset pricing theory  Efficient Markets Hypothesis  Corporate finance  Derivative Securities, Fixed Income Analysis

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory  Asset pricing theory  Efficient Markets Hypothesis  Corporate finance  Derivative Securities, Fixed Income Analysis  Market Microstructure

第十九屆亞太財務經濟會計及管理會議 Major developments over last 40 years  Portfolio theory  Asset pricing theory  Efficient Markets Hypothesis  Corporate finance  Derivative Securities, Fixed Income Analysis  Market Microstructure  Behavioral Finance

第十九屆亞太財務經濟會計及管理會議 The EMH was responsible for the GFC “Neo-liberal policy prescriptions flow from the core theoretical belief in the superiority of unregulated markets - particularly unregulated financial markets. These claims ultimately rest on the "efficient-markets hypothesis", which, in its strongest form, claims that financial-market prices, like stock-market prices, incorporate all available information, and therefore represent the best possible estimate of asset prices. It follows, therefore, that if markets are fully efficient and prices fully informed, there is no reason to believe that asset-price bubbles are probable; and if these do occur, markets will self-correct; and that there is therefore no justification for government intervention to stop them occurring” Kevin Rudd The Monthly 42 (February 2009)

第十九屆亞太財務經濟會計及管理會議 The EMH was responsible for the GFC “The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight. ‘Surely, none of this could be happening in a rational, efficient world,’ they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking.” Jeremy Grantham (quoted in the New York Times June 5, 2009)

第十九屆亞太財務經濟會計及管理會議 Grantham’s performance over GFC Sharpe Ratio Alpha (market benchmark) Alpha (Fama French 3 factor) GMO US Equity Allocation Fund; Class III Shares (-0.94) (-0.80) GMO Tobacco-Free Core Fund; Class III Shares (-0.71) (-0.81) GMO US Quality Equity Fund; Class VI Shares (-0.31) (-0.11) GMO US Quality Equity Fund; Class V Shares (-0.30) (-0.10) GMO US Quality Equity Fund; Class IV Shares (-0.31) (-0.12) GMO US Quality Equity Fund; Class III Shares (-0.33) (-0.13) GMO Tax-Managed US Equities Fund; Class III Shares (-1.62) (-1.40) GMO US Growth Fund; Class M Shares (-0.86) (-1.15) GMO US Core Equity Fund; Class M Shares (-1.46) (-1.37) GMO US Core Equity Fund; Class VI Shares (-1.32) (-1.23) GMO US Core Equity Fund; Class IV Shares (-1.33) (-1.24) GMO US Core Equity Fund; Class III Shares (-1.36) (-1.26) GMO US Intrinsic Value Fund; Class III Shares (-2.44) (-2.30) GMO US Small/Mid Cap Growth Fund; Class III Shares (-1.24) (-2.21) S&P500 Market Data from August 07 – May 09 from CRSP Mutual Funds Database

第十九屆亞太財務經濟會計及管理會議 Efficient Markets Hypothesis  No trader’s information gives them an advantage  If information is already incorporated in price

第十九屆亞太財務經濟會計及管理會議 Examples of EMH applications  Weak form Efficient Markets Hypothesis  Example: trading rule tests  Does active management outperform passive benchmark?  Semi-strong form EMH  Example: Event studies  What information releases are material to investors?  Empirical asset pricing  Example: Orthogonality condition in GMM  Can we explain cross sectional dispersion in required return?

第十九屆亞太財務經濟會計及管理會議 Efficient Markets Hypothesis  Tests of Efficient Markets Hypothesis  Does the market efficiently process information?  What is information?  Estimation of parameters  Does the market efficiently price risk?  What determines the cross section of expected returns?

第十九屆亞太財務經濟會計及管理會議 Efficient Markets Hypothesis

第十九屆亞太財務經濟會計及管理會議 Random Walk Hypothesis

第十九屆亞太財務經濟會計及管理會議 Random Walk Hypothesis “The series looks like a ‘wandering’ one, almost as if once a week the Demon of Chance drew a random number from a symmetrical population of fixed dispersion and added it to the current price to determine the next week’s price” Kendall (1953)

第十九屆亞太財務經濟會計及管理會議 Random Walk Hypothesis  Serial Correlation tests  Variance ratio tests

第十九屆亞太財務經濟會計及管理會議 Random Walk Hypothesis  Serial Correlation tests  Variance ratio tests  Momentum Zero investment portfolio

第十九屆亞太財務經濟會計及管理會議 Random Walk Hypothesis  Well established statistical properties  Strong assumption of stationarity  Time varying conditional expectations not allowed  Neither necessary nor sufficient for EMH

第十九屆亞太財務經濟會計及管理會議 Trading rule tests of EMH  Timmerman (2007) survey  Naïve models using past sample means hard to beat  Recent financial data is most relevant  Short lived episodes of limited predictability  Predictability is not profitability  Necessity: Do not consider all possible patterns of returns  Sufficiency: Cannot profit if all markets rise and fall together

第十九屆亞太財務經濟會計及管理會議 Examining profitability  Appearance of short term profitability..  at the expense of significant downside risk (Goetzmann et al. 2008) Benchmark Portfolio Société Générale Jan 2008 Jérôme Kerviel Nick Leeson

第十九屆亞太財務經濟會計及管理會議 An important seminal reference …

第十九屆亞太財務經濟會計及管理會議 Trading Rules: Cowles 1933  Cowles, A., 1933 Can stock market forecasters forecast? Econometrica  William Peter Hamilton’s Track Record  Classify editorials as Sell, Hold or Buy  Novel bootstrap in strategy space Return on DJI

第十九屆亞太財務經濟會計及管理會議 Trading rule predicting sign of excess return January December 2005 Factor-augmented AR logit based on prior 120 month rolling window Trading rule value S&P500 value

第十九屆亞太財務經濟會計及管理會議 Cowles Bootstrap Jan 1970-Dec 2005 Annualized excess fund return 2.203% Sharpe ratio of fund Sharpe ratio of S&P Peseran & Timmermann (1992) p-value 4.83% Cowles bootstrap p-value 6.32%

第十九屆亞太財務經濟會計及管理會議 Standard Event Study approach t r t1 r t2 r t3 r t4 u 01 u 11 u 21 … u 02 u 12 u 22 … u 03 u 13 u 23 … u 04 u 14 u 24 … u 05 u 15 u 25 … EVENT

第十九屆亞太財務經濟會計及管理會議 Fama Fisher Jensen and Roll

第十九屆亞太財務經濟會計及管理會議 FFJR Redux

第十九屆亞太財務經濟會計及管理會議 Bottom line: is EMH useful?  For whom is the EMH true?  Uninformed investors with limited capital?  Large well informed and well endowed investors?  Does it have practical implications?  Benchmark comparisons for fund investors?  What information is material to investors?  Useful measures of risk and investment risk premia?

第十九屆亞太財務經濟會計及管理會議 The EMH was not responsible for GFC  Banks invested in beta, thinking it was alpha  They borrowed to invest in market risk  Significant debt exposure at cusp of crisis  Banks failed to predict the collapse of the market  A direct implication of the EMH