What is the hypothesis of Fama (1970) for an efficient market?
A market where prices fully reflect available information.
Which forms of market efficiency exists?
Strong
private, monopolistic and insider information
Semi-Strong
all publicly available infromation
Weak
all information about historic prices
What does the market efficiency implicate in terms of the risk premium?
The Average excess return is the risk premium. It only reflects the compesatiotn for systematic risk.
State some implications of the market efficiency
Price changes cannot be predicted beyond risk compesation, because the price is reflecting all information
News will affect the current price, but not the average expected return. Expecttion on the current price are not affected
News with a certain ferquency do not influence the price in the long run.
There are no patterns in stocks movement
Stock prices are predictable, if risk premium is time-varying
Define the Martingale Model
What is the fundamental problem with the Martingale Model?
How could be the Martingale Model be transformed?
Does not take the risk into account. Expected return could be a compensation for systematic risk
The characteristics are neither necessary or sufficient conditions
mt+1 is a discount factor for time and risk preference
Define the fundamentalist model of valuation
The dividend discount model, p is the discount factor
If N goes to infinty, what does the dividend discount imply model on the law of iterated expectations?
The Value would converge to zero, therfore it implies that rate of return is a fair game under the fundamentalitist view
Why was the fundamentalist model of valution introduced?
The idea of efficient security return has caused confusion. The Price Movement should be smoother than random. Therefore, security prices could be determined by discounting future cash-flows.
What does the law of iterated expectations in terms of information state? How does it fit to the market efficiency?
The best forecast with limited information depends on the forecast of superior information.
One cannont use limited information to predict the forecast error if one has superior information
What are the view of Grossmann and Stiglitz (1980) for abnormal returns?
If there are costs for gathering informaton, abnormal returns are possible because they are compensating the investors expenses. This does not have to mean the market is not efficient
If the random walk holds, what should be Cowles-Jones Ratio hold? Explain the ratio.
What are their insights?
It should converge to 1, which would mean we have a random walk because sequences and reversal are eqully distributed
The fact that the ratio exceeds 1 for many historical stock returns, there is an evidence of a structure in stock prices
What could be a better setup for the Rand Walk Model?
The Random Walk Model is is added by a drift. The drift represents the positive retruns expectation as a compensation for systematic risk.
Define the reversal and sequence in the CJ-Ratio
Reversal -> SubSequence of returns with a different sign
Sequence -> SubSequence of return with the same sign
What should be the autocorrelation and the variance ratio, if the random walks holds?
The autocorrelation should be zero and the variance ratio should be 1.
Why are event studies used?
To test empirically the semi strong makert efficiency
Why are event studies the most important method to empirically test a semi strong market?
Because the measure the valuation effect of on an economic event.
Name the the periods for a time interal in an event studies and explain them
Pre-Announcement
Measures possible anticipation
Announcement Period
usually a window of 2 days
Post-announcement Period
New Information may influence the price
At which date can an economic event value influence the information?
Announcement Date
Placement Date
What are possible financial ecnomic events?
Dividend Pay-out
Issue of shares or debt
Restructuring (M&A)
What is the difference between BHAR and CAR?
CAR is cumulates the abnormals return, where BHAR multiplies the abnormal returns
CAR are less sensitive while BHAR resembles a more realistic investment strategy
Is it possible to predict the Price in the Martinagle Model?
If the expected price change is 0, there is no forecasting possible. Furthermore, if the change of the price is a fair game, forecast is also not possible due to the random walk.
Evaluate the Martingale Model
For a long time it was considered as a necessary condition for the market efficiency. However, studies proves that it is possible to outpeform the martingale mode.
Compare the Random Walk Model with the Martingale Model.
The Random Walk is more restrictive. Not allowing stochastic volatility, which implies no auto covaraince and heteroscedasticity.
Is it possible to observe hetroscedacity, even in the random walk modell?
Yes, empirical researches are showing that there are clusters for high/low volatility in returns
What Problem occuers with the testing pf market efficiency?
A Test of the market efficiency assumes a asset pricing models which defines normal returns
The Joins Hyoptheisis problem is when the nullhypotheis is getting rejected due two possible reasons
Market is inefficient
An incorrect asset pricing model is used
It is difficult to find out which of the two possible reasons are the problem
Which phenomona appears, if the Variance Ratio exceed 1 and drops under 1?
Mean Reversion
How is the Price in a fully reflected market calculated, also include the risky asset and the risk premium
What is the Random Walk Price Model?
Todays Price + stochastic process. The stochastical process is i.i.d.
What are the empirical results from MacCinlay on the abnormal returns after an announcement?
No News
CAR is at 0
Good News
CAR is increasing, espacially at the announcement day
Bad News
CAR is decreasing, espacially at the announcement day
State the regression and the nullhypothesis for testing the semi market efficiency
H0 = Abnormal return, mean and variance should be 0
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