1. The Market Hypothesis The Efficient Market Hypothesis

2. 9-2 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Efficient Market Hypothesis (EMH) Do security prices reflect information ? Why look at market efficiency – –Implications for business and corporate finance – –Implications for investment

3. 9-3 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Forms of the EMH Weak Semi-strong Strong

4. 9-4 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Types of Stock Analysis Technical Analysis - using prices and volume information to predict future prices – –Weak form efficiency & technical analysis Fundamental Analysis - using economic and accounting information to predict stock prices – –Semi strong form efficiency & fundamental analysis

5. 9-5 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Why are price changes random? – –Prices react to information – –Flow of information is random – –Therefore, price changes are random Random Walk Hypothesis

6. SecurityPrices Time Irwin/McGraw- Hill © The McGraw-Hill Companies, Inc., 1998 9-4 Random Walk with Positive Trend

7. 9-7 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Event studies Assessing performance of professional managers Testing some trading rule Empirical Tests of Market Efficiency Empirical Tests of Market Efficiency

8. 0+t-t Announcement Date Irwin/McGraw- Hill © The McGraw-Hill Companies, Inc., 19989-13 Returns Over Time

9. 9-9 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Technical Analysis Fundamental Analysis Anomalies Exist What Does the Evidence Show?

10. 9-10 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Small Firm Effect (January Effect) Small Firm Effect (January Effect) Neglected Firm Neglected Firm Market to Book Ratios Market to Book Ratios Reversals Reversals Value Line Enigma Value Line Enigma Post-Earnings Announcement Drift Post-Earnings Announcement Drift Higher Level Correlation in Security Prices Higher Level Correlation in Security Prices Anomalies

11. 9-11 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Mutual Fund and Professional Manager Performance Some evidence of persistent positive and negative performance Potential measurement error for benchmark returns – –Style changes – –May be risk premiums Superstar phenomenon

12. 9-12 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Active Management Active Management –Security analysis –Timing Passive Management Passive Management –Buy and Hold –Index Funds Implications of Efficiency for Active or Passive Management

13. 9-13 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1998 Even if the market is efficient a role exists for portfolio management – –Appropriate risk level – –Tax considerations – –Other considerations Market Efficiency and Portfolio Management