复旦大学：《投资学讲义》（英文版） Chapter 16 Market efficiency and active portfolio management

Chapter 16 Market efficiency and active portfolio management Fan longzhen

Chapter 16 Market efficiency and active portfolio management Fan Longzhen

Types of market efficiency The weak-form of efficiency: price accurately reflect all information that can be derived by examining market trading data such as past prices trading volume short Interest rate. etc The semi-strong form of efficiency: prices accurately reflect all public available information, including past prices. fundamental data on the firms product line quality of management, balance sheet composition, patents held, earning forecasts, accounting practice, etc The strong-form of efficiency: prices accurately reflect all information that is known by any one, including inside Information

Types of market efficiency • The weak-form of efficiency: price accurately reflect all information that can be derived by examining market trading data such as past prices, trading volume, short interest rate, etc. • The semi-strong form of efficiency: prices accurately reflect all public available information, including past prices, fundamental data on the firm’s product line, quality of management, balance sheet composition, patents held, earning forecasts, accounting practice, etc. • The strong-form of efficiency: prices accurately reflect all information that is known by any one, including inside information

Some words about market efficienc An inefficiency ought to be an exploitable opportunity. If there is nothing investors can properly exploit in a systematic way, then it is very hard to say that information is not being properly incorporated into stock prices; Richard roll Financial markets are efficient because they dont allow investors to earn above-average returns without taking above-average risk---Burton malkiel The efficient markets theory holds that the trading by investors in a free and competitive market drives security prices to the true fundamental values. the market can better assess what a stock or a bond is worth than any individual investor ---Andrei shleifer

Some words about market efficiency • An inefficiency ought to be an exploitable opportunity. If there is nothing investors can properly exploit in a systematic way, then it is very hard to say that information is not being properly incorporated into stock prices;--- Richard Roll • Financial markets are efficient because they don’t allow investors to earn above-average returns without taking above-average risk---Burton Malkiel • The efficient markets theory holds that the trading by investors in a free and competitive market drives security prices to the true “fundamental” values. The market can better assess what a stock or a bond is worth than any individual investor.---Andrei Shleifer

Info ormation arrivals and price updates The efficient market theory states that security prices reflect all currently available information One interesting empirical question is: how does the market adjust to the arrival of new information Event study methodology is one such tool to measure the economic impact of events

Information arrivals and price updates • The efficient market theory states that security prices reflect all currently available information. • One interesting empirical question is : how does the market adjust to the arrival of new information? • Event study methodology is one such tool to measure the economic impact of events

Paths to efficient prices How does information get impounded in prices If gathering information is costly can price still perfectly reflect information? If market prices deviate from their fundamental values, what bring them back? How do prices derivate from their fundamental values in the first place?

Paths to efficient prices • How does information get impounded in prices? • If gathering information is costly, can price still perfectly reflect information? • If market prices deviate from their fundamental values, what bring them back? • How do prices derivate from their fundamental values in the first place?

Limited of arbitrage Arbitrage plays a critical role in the analysis of securities markets because its effect is to bring prices to fundamental values and to keep market to efficient In practice the arbitrageurs are of capital constrained, and their effectiveness in bring prices to fundamental values is limited

Limited of arbitrage • Arbitrage plays a critical role in the analysis of securities markets, because its effect is to bring prices to fundamental values and to keep market to efficient. • In practice, the arbitrageurs are of capital constrained, and their effectiveness in bring prices to fundamental values is limited

Mutual fund performance equity funds: on average, active managers underperform index funds when both are measured after expenses, and those that do outperform in one-period are not typically the ones who outperform in the next Fixed-income funds on average bond funds underperform passive fixed -income indexes by an amount roughly equal to expense, and there is no evidence that past performance can predict future performance

Mutual fund performance • Equity funds: on average, active managers underperform index funds when both are measured after expenses, and those that do outperform in one-period are not typically the ones who outperform in the next. • Fixed-income funds: on average, bond funds underperform passive fixed-income indexes by an amount roughly equal to expense, and there is no evidence that past performance can predict future performance

Anomalies · The size effects The value effect The short-term momentum The long-term reversal The new issues puzzle The January effect

Anomalies • The size effects • The value effect • The short-term momentum • The long-term reversal • The new issues puzzle • The January effect…

The bottom line The efficient market hypothesis is a useful framework for modeling financial markets Like any model, the efficient market hypothesis is not a perfect description of reality; some prices are almost certainly wrons However, it would be naive to think that prices are al ways wrong or that it is easy to exploit pricing errors Instead of asking whether or not the market is efficient, the more relevant questions are -how efficient is the market? ---how does the market react to new information arrivals? And why? c--what are the mechanisms that bring market prices to fundamental values?

The bottom line • The efficient market hypothesis is a useful framework for modeling financial markets. • Like any model, the efficient market hypothesis is not a perfect description of reality; some prices are almost certainly “wrong”. • However, it would be naïve to think that prices are always wrong or that it is easy to exploit pricing errors. • Instead of asking whether or not the market is efficient, the more relevant questions are: • ---how efficient is the market? • ---how does the market react to new information arrivals? And why? • ---what are the mechanisms that bring market prices to fundamental values?

Event studies Impact of "event on security prices Earning announcement; stock split; block trade; merger announcement; regulatory change Need a model of“ normal or“ expected returns constant mean market model: multifactor models abnormal returns=Actual-normal study abnormal returns: moments cumulative abnormal returns statistical inference

Event studies • Impact of “event” on security prices: • Earning announcement; stock split; block trade; merger • announcement; regulatory change. • Need a model of “normal” or “expected” returns: • constant mean; market model; multifactor models. • Abnormal returns=Actual-Normal • study abnormal returns: moments • cumulative abnormal returns • statistical inference. •