Chapter 17 - Capital market efficiency. On completion of this chapter students will know how to: Understand the concept of market efficiency, distinguish between different categories of market efficiency, understand the methods used to test for market efficiency, understand the major trends in tests of market efficiency that have uncovered evidence that is "anomalous" from a market efficiency viewpoint,. | Chapter 17 Capital Market Efficiency 2 2 2 2 2 2 2 2 2 Learning Objectives Understand the concept of market efficiency. Distinguish between different categories of market efficiency. Understand the methods used to test for market efficiency. 2 2 2 2 2 2 2 2 2 Learning Objectives (cont.) Understand the major trends in tests of market efficiency that have uncovered evidence that is ‘anomalous’ from a market efficiency viewpoint. Understand the implications of the developing field of behavioural finance for the efficient market hypothesis. Understand the implications of market efficiency for investors and financial managers. 3 3 3 3 3 3 3 Efficient Market Hypothesis (EMH) ‘EMH’: that the price of a security (such as a share) accurately reflects all available information. If the market processes new information efficiently, the reaction of market prices to new information will be instantaneous and unbiased. The concept of efficient markets with respect to information was . | Chapter 17 Capital Market Efficiency 2 2 2 2 2 2 2 2 2 Learning Objectives Understand the concept of market efficiency. Distinguish between different categories of market efficiency. Understand the methods used to test for market efficiency. 2 2 2 2 2 2 2 2 2 Learning Objectives (cont.) Understand the major trends in tests of market efficiency that have uncovered evidence that is ‘anomalous’ from a market efficiency viewpoint. Understand the implications of the developing field of behavioural finance for the efficient market hypothesis. Understand the implications of market efficiency for investors and financial managers. 3 3 3 3 3 3 3 Efficient Market Hypothesis (EMH) ‘EMH’: that the price of a security (such as a share) accurately reflects all available information. If the market processes new information efficiently, the reaction of market prices to new information will be instantaneous and unbiased. The concept of efficient markets with respect to information was introduced by Fama (1970). 4 4 4 4 4 4 4 A Non-Instantaneous Price Reaction An instantaneous price reaction would, in practice, mean that after new information becomes available it should be fully reflected in the next price established in the market. If the market often fails to react instantaneously, share traders can develop simple rules to generate excess profits. Simply purchase shares immediately after a company makes an unanticipated announcement of good news. If the reaction is not instantaneous, a positive profit will be earned. 5 5 5 5 5 A Biased Price Reaction Overreaction A biased response of a price to information in which the initial price movement can be expected to be reversed. Underreaction A biased response of a price to information in which the initial price movement can be expected to continue. 6 6 6 6 6 Categories of Capital Market Efficiency The EMH implies that investors cannot earn abnormal returns by using information that is already available. Abnormal returns are .
