1 1 Ch11&12 – MBA 566 Efficient Market Hypothesis vs. Behavioral Finance Market Efficiency Random walk versus market efficiency Versions of market efficiency Technical analysis vs. fundamental analysis Predictors of future returns and market anomalies Behavioral finance

2 2 Ch11&12 – MBA 566 Cumulative Abnormal Returns Around Takeover Attempts: Target Companies

3 3 Ch11&12 – MBA 566 Stock Price Reaction to CNBC Reports

4 4 Ch11&12 – MBA 566 Stock prices fully and accurately reflect publicly available information. Once information becomes available, market participants analyze it. Competition assures prices reflect information. What does competition mean here? -- page 351 Is there a role for active portfolio management in an efficient market? EMH and Competition

5 5 Ch11&12 – MBA 566 Weak Semi-strong Strong See page 348. Forms of the EMH

6 6 Ch11&12 – MBA 566 Technical Analysis - using prices and volume information to predict future prices. Weak form efficiency & technical analysis Chartist Relative strength versus resistance levels Fundamental Analysis - using economic and accounting information to predict stock prices. Semi strong form efficiency & fundamental analysis Types of Stock Analysis

7 7 Ch11&12 – MBA 566 Technical Analysis Relative strength – page 349 Resistence levels – upper bound or Support levels – lower bound Whether a workable technical trading rule will continue to work in the future once it becomes publicly known?

8 8 Ch11&12 – MBA 566 Fundamental Analysis Uses earnings and dividend prospects of the firm, expectations of future interest rates, and risk evaluation of the firm to determine proper stock prices. Fundamental analysis is much beyond identifying well-run firms with good prospects. It is to identify companies better than every else’s estimate.

9 9 Ch11&12 – MBA 566 Active Management Security analysis Timing Passive Management Buy and Hold Index Funds Active or Passive Management

10 Ch11&12 – MBA 566 Even if the market is efficient a role exists for portfolio management: Appropriate risk level Tax considerations Other considerations Market Efficiency & Portfolio Management

11 Ch11&12 – MBA 566 Event studies Assessing performance of professional managers Testing some trading rule Empirical Tests of Market Efficiency

12 Ch11&12 – MBA 566 Magnitude Issue Selection Bias Issue: investing in small stocks Lucky Event Issue Issues in Examining the Results

13 Ch11&12 – MBA 566 Weak-Form Tests Serial Correlation Momentum Returns over Long Horizons

14 Ch11&12 – MBA 566 Predictors of Broad Market Returns Fama and French Aggregate returns are higher with higher dividend ratios Campbell and Shiller Earnings yield can predict market returns Keim and Stambaugh Bond spreads can predict market returns

15 Ch11&12 – MBA 566 P/E Effect Small Firm Effect (January Effect) Neglected Firm Book-to-Market Effects Post-Earnings Announcement Drift Anomalies

16 Ch11&12 – MBA 566 Returns in Excess of Risk-Free Rate and in excess of the Security Market Line for 10 Size-Based Portfolios, 1926 – 2005

17 Ch11&12 – MBA 566 Average Monthly Returns as a Function of the Book-To Market Ratio, 1963 – 2004

18 Ch11&12 – MBA 566 Cumulative Abnormal Returns in Response to Earnings Announcements

19 Ch11&12 – MBA 566 Some evidence of persistent positive and negative performance. Potential measurement error for benchmark returns. Style changes May be risk premiums Mutual Fund Performance

20 Ch11&12 – MBA 566 Persistence of Mutual Fund Performance

21 Ch11&12 – MBA 566 Behavioral Finance The premise of behavioral finance is that conventional financial theory ignores how real people make decisions and that people make a difference. Investors Do Not Always Process Information Correctly Investors Often Make Inconsistent or Systematically Suboptimal Decisions

22 Ch11&12 – MBA 566 Behavioral Biases Framing Decisions seem to be affected by how choices are framed – page 387 example Mental Accounting A special form of framing in which people segregate certain decisions example Regret Avoidance Individuals would have more regrets when their decisions are more unconventional example Prospect Theory Traders become risk seeking after they lose money

23 Ch11&12 – MBA 566 Prospect Theory Graphs

24 Ch11&12 – MBA 566 Limits to Arbitrage Fundamental Risk Implementation Costs Model Risk

25 Ch11&12 – MBA 566 Limits to Arbitrage and the Law of One Price Violations Siamese Twin Companies Equity Carve-outs Closed-End Funds

26 Ch11&12 – MBA 566 Trend and Corrections Dow theory – page 397 Primary trend Secondary/intermediate trend Tertiary or minor trends Moving average Typically 200 days or 53 weeks Bullish versus bearish – page 398 Breadth – page 400 Advances versus declines – page 401 Sentiment indicator Trin statistic Confidence index Put-call ratio