Lecture 4a Efficient Markets 2016_17 v.8.pdfVIP

BMAN71171 Portfolio Investment Lecture 4a: Efficiency of Capital Markets Chris Godfrey (christopher.godfrey@manchester.ac.uk) Office Hours: Wednesdays, email for appointment 1 Source: Analysis of Investments Management of Portfolios Ninth Edition by Frank K. Reilly Keith C. Brown 2 Suggested Reading: Reading Reilly Brown: 9th edition, Chapter 6, Efficient Capital Markets; 6th edition, Chapter 7; 2015 edition, Chapter 4 Content Overview ? Defining an efficient capital market ? Alternative Efficient Market Hypotheses ? Implications of the evidence supporting and not supporting the EMH for Portfolio Management 3 Efficient Markets Defined ? An Efficient Market is one in which security prices adjust rapidly to the arrival of new information. ? The current market price reflects all available information about the security ? There is then said to be an “informationally efficient” market ? There has been a lot of research on whether this is so. Why? – Whether markets are deemed efficient or not has significant implications for investors and portfolio managers. – Cause of many subsequent controversies, and the evidence suggests several anomalies. – Such anomalies will need to be considered during the portfolio construction process 4 Requirements for an Efficient Market ? What set of assumptions imply an efficient capital market? – A large number of competing profit-maximizing participants analyze and value securities, each independently of the others – New information regarding securities comes to the market in a random fashion (i.e. Information is not known previously or in any way predictable – if predicted, the information would already be impounded in the price) – Profit-maximizing investors adjust security prices rapidly through their buying and selling to reflect the effect of new information ? The price may over/ under adjust but you cannot know when this imperfect adjustment may happen