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chAapter 4 lecture notes.docx

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ACC 706
Shadi Farshadfar

Chapter 4 lecture notes Recap of ch 3: Decision making theory - Risk averse - Rational decision making - Uncertainty Investment theory - Rational - Risk averse Chapter 4 The meaning of market efficiency When market becomes efficient? - Gathering relevant information is costly, assume some rational investors are going to take advantage of new info - Share price will not be affected by decision making of few investors, they (all) have to make a right decision -> share prices fully reflect new information Weak form - New information is released and it definitely effects the share price - Share prices fully reflect information past or historical price only Semi- strong - Publicly available information - Historical (past) price of stock - Efficient securities market is one where the prices of the securities traded on that market at all times fully reflect all info that is publicly known about those securities ; - Fully reflect information: they make not make the same decision, because they all have their own past believes. But our investors based on decision making theory, their decision making is independent - How do the share prices fully reflect the new info? – if this is good news, share price go up, bad – down. - On average the market uses all available information - Market price is the average of the various individual investment decision Strong form - All information (public&private) Implications of efficient securities markets for financial reporting 1. Acc policies do not effect securities prices 1) Acc policies do not have direct cash flow effect 2) Firms disclose their selected policy 3) Firms disclose any additional info needed to convert from one method to another 2. D 3. Firms should not be overly concerned about the naive investor when 4. Accountants are in competition with other providers of information e.g. websites and other media So how to survive? - Providing useful and cost effective information - Recognizing that the ultimate responsibility of acc info is society. This can encouraged by  Standards that promote useful info  Penalties for individuals abuse  Ethical Grossman-Stiglitz Paradox If markets are perfectly efficient, why gather information because they can’t beat the market; but if no one bothers to gather information, prices will not fully reflect available info, in which case there would be little reason to trade and markets would eventually collapse Collapse because informed investor will not gather investor will make decision based on stock prices - No more gathering information - Prices will go up - Eventually will go down, market will collapse Changes occur: - BN or GN - Someone sells share just because they need money - By spending time and money, they can get even insider info Conclusion: cannot make decisions based on share price Paradox solution - Market prices are affected by the presence of noise trading  Noise trading or liquidity t
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