1. Lecture 7: Efficient Market Hypothesis
Dr Larisa Yarovaya

2. Reading this week A chapter 13 pp. 542-590. BKM chapter 8 pp. 234-258.
RWJJ chapter 13 pp
RWJ1 chapter 10 pp
RWJ2 chapter 14 pp
Malkiel, Burton G. `The efficient market hypothesis and its critics’. Winter Journal of Economic Perspectives. 17(1). pp

3. Lesson Plan: 1) Capital Asset Pricing Model (CAPM) 1) Random Walk
Previous Lecture
Today
Knowledge and Understanding
1) Capital Asset Pricing Model (CAPM)
1) Random Walk
2) Portfolio Diversification (3 assets)
2) Efficient Market Hypothesis
3) Weighted Average Cost of Capital
3) Implications of EMH
Intellectual, practical, affective and transferable skills
1) Task 1 CAPM
1) Group Discussion
2) Task 2 Business and Financial Risks
2) WACC calculation (will be included in EXAM)

4. Random walk
Random walk is a purely random movement that is not being influenced in anyway, apart from `randomness’.
In finance a random walk is the concept in which movements of a stock price are unpredictable (i.e. follow a random walk).
Then it follows that since movements of a stock price are unpredictable, then given all the information today, future stock price movements cannot be predicted.
Then factors that will influence future values of a stock price will be considered `new’ news that no one has anticipated before.

5. The Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis (EMH) posits that prices of securities already fully reflect ALL available information about those securities.
There are 3 form of EMH:
(I) Weak-form;
(II) Semistrong-form; and
(III) Strong-form.

6. Weak-form EMH
Weak-form EMH asserts that stock prices already reflect all information that can be derived by examining market trading data such as the history of past trading;
Technical (trend) analysis is fruitless;
Past stock price data are publicly available and virtually costless to obtain.

7. Semistrong-form EMH
Semistrong-form EMH states that all publicly available information regarding the prospects of a firm must already be reflected in the stock price.
Such information includes, in addition to past prices, fundamental data on the firm’s product line, quality of management, Balance Sheet composition, earnings forecast, accounting practices, etc.
Again, if any investor has access to such information from publicly available sources, one would expect it to be reflected in stock prices

8. Strong-form
Strong-form EMH states that stock prices reflect all information relevant to the firm, even including information available only to company insiders.
This version is quite extreme.
Moreover, defining `insider trading’ is not always easy.

9. ? 𝟏𝟎 𝐦𝐢𝐧 Random Walk and the EMH
A forecast about favorable future performance leads instead to favorable current performance because market participants all try to get in on the action before the price jump!
Why are price changes random? ?
𝟏𝟎 𝐦𝐢𝐧

10. Rational expectations
As soon as there is any information that a stock is underpriced and offers a profit opportunity, investors flock to buy this stock and immediately bid up its price to a fair level.
If prices are bid immediately to fair levels, given all available information, it must be that prices increase or decrease only in response to new information.
New information by definition must be unpredictable => stock prices that change in response to new unpredictable information also must move unpredictably!

11. ? 20 min Discussion Implications of EMH;
Technical Analysis vs Fundamental Analysis;
Active strategy vs Passive strategy ?
20 min

12. Task for the next week
Read in Glen Arnold (2013) Chapter 19th “Dividend Policy”
Prepare to answer the question: why company should pay high/low/fixed dividends or to pay dividend as residual?

13. Task today
Seminar 7 task
30 min + 15 min discussion

14. Thank you for your attention