1. QDai for FEUNL Finanças November 9

2. QDai for FEUNL Topics covered  Efficient market theory Definition Implications Foundation Types Evidence

3. QDai for FEUNL Efficient market theory  Efficient market:  Implications of the efficient market theory:

4. QDai for FEUNL Reaction of Stock Price to New Information in Efficient and Inefficient Markets Stock Price -30-20-10 0+10+20+30 Days before (-) and after (+) announcement Efficient market response to “good news”

5. QDai for FEUNL Reaction of Stock Price to New Information in Efficient and Inefficient Markets Stock Price -30-20-10 0+10+20+30 Days before (-) and after (+) announcement Efficient market response to “bad news”

6. QDai for FEUNL Foundations of market efficiency  Rationality:  Independent deviations from rationality:  Arbitrage

7. QDai for FEUNL Different types of efficiency  Weak form:  Semistrong form:  Strong form:

8. QDai for FEUNL Weak Form Market Efficiency  Security prices reflect  P t =  Since stock prices only respond to new information, which by definition arrives randomly, stock prices are said to follow

9. QDai for FEUNL Semi-Strong Form of Market Efficiency  Semi-strong form:  Historical price and volume information

10. QDai for FEUNL Strong Form of Market Efficiency  Strong form:  Incorporates weak and semi-strong form efficiency.  Anything pertinent to the stock and known to at least one investor is already incorporated into the security’s price.

11. QDai for FEUNL The Evidence for market efficiency  Are changes in stock prices random? Are there profitable “trading rules”?  Event studies: does the market quickly and accurately respond to new information?  The record of professionally managed investment firms.  Insider trading

12. QDai for FEUNL Are Changes in Stock Prices Random?  Random stock price changes support  Serial correlation:

13. QDai for FEUNL What Pattern Do You See?

14. QDai for FEUNL Are Changes in Stock Prices Random?  The serial correlation coefficients for firms have been found to be  The evidence is consistent with

15. QDai for FEUNL Event Studies  Event studies are one type of test of the semi- strong form of market efficiency  Examines prices and returns around the arrival of new information: under reaction, overreaction, early reaction, delayed reaction around the event…  The abnormal return of a given stock on a particular day: AR= R – R M AR= R – ( + R M )  Cumulative abnormal returns (CAR)

16. QDai for FEUNL Event Studies: Dividend Omissions Efficient market response to “bad news” S.H. Szewczyk, G.P. Tsetsekos, and Z. Santout “Do Dividend Omissions Signal Future Earnings or Past Earnings?” Journal of Investing (Spring 1997)

17. QDai for FEUNL Event studies  This metholdology has been applied to a large number of corporate events Dividend announcement Stock repurchase Merger and aquisition Earnings announcement Change in the management etc  These studies are generally supportive of

18. QDai for FEUNL The Record of Mutual Funds  If the market is semi-strong efficient, then mutual-fund managers should  Compare the performance of professionally managed mutual funds with the return on a market index.

19. QDai for FEUNL The Record of Mutual Funds Taken from Lubos Pastor and Robert F. Stambaugh, “Mutual Fund Performance and Seemingly Unrelated Assets,” Journal of Financial Exonomics, 63 (2002).

20. QDai for FEUNL Insider trading  Trades by insiders are found to be related to large profits.  The evidence is

21. QDai for FEUNL Behavial challenge to market efficiency  Investors do not behave rationally  Patterms in deviation from rationality  Arbitrage is risky

22. QDai for FEUNL Empirical Challenges to Market Efficiency