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Lecture 23

FIN 302 Lecture 23: Session 23

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University of Michigan - Ann Arbor
FIN 302
Denis Sosyura

SESSION 23: EFFICIENT MARKET, ANOMALIES, AND INVESTING, PART 1 - Drivers of market efficiency - Market limitations and investor biases - Market anomalies and implications for personal investing MARKET EFFICIENCY: DIFFERENT PERSPECTIVES - In an efficient market, prices reflect all public information and adjust immediately if new information is released - all assets are fairly priced 1. Alan Greenspan: Prices in the marketplace… are by definition the right prices. Anyone who’s got a different view is bringing information to the market which it doesn’t have, something I doubt very much a. Anyone who has a different information as the current price has new information and is bringing it to the market 2. Buffet: Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn’t do any good to look at the cards. WHAT DRIVES MARKET EFFICIENCY? - Almost instantaneous access of investors to the release of new information - Bloomberg, Reuters, Electronic news wires - Thousands of traders constantly monitoring the news and waiting to trade on new information - Greed - people and investors are looking to turn a profit - “Greed is good” - greed pushes investors to find new information - Markets are becoming more efficient as the transfer of information is becoming better CNBC 1. Anchor - what they say 2. Movements in the stock price - the processing of information a. As soon as they speak, the markets are already reacting within seconds b. “Market Efficiency in Real Time” - youtube WHY ARE EFFICIENT MARKETS IMPORTANT FOR FIRMS? - Firms are run by professional managers rather than by firm’s owners (shareholders) - Advantage: managerial expertise - Disadvantage: shrinking and self-interest of mangers - If markets quickly process new data about the firm, we can just monitor the stock price to evaluate managerial decisions - If managers destroy value, we can see that and fire them - Markets are also a good reflection of the upper level management MINI-CASE: MANAGEMENT CRISIS AT YAHOO: A MARKET PERSPECTIVE Case Background: - The premium was offered up to 70%, but the board of Yahoo! rejected the offer because they thought Microsoft was undervaluing the firm - Rejecting the bid had a negative effect on the price - The stock jumped after the resignation of the CEO, which reflects how investors view the management Graph - The board begins to resist, so the price went down because investors realized that the deal would not go through - The company has been doing much better after the management change DISCUSSION: EFFICIENT MARKETS AND MANAGERIAL DECISIONS - Why did the CEO oppose the takeover and ultimately fired? - The CEO would lose his job - Microsoft CEO would take over - Golden parachute - severance of the CEO after losing their job and the company takeover - His issues with the ego, job security, and power ended up ruining his company - He would lie to the press, so he would keep his job - Market is always looking for undervalued companies, so if Yahoo were truly a good company, the price would rise MARKET EFFICIENCY: AN INVESTOR’S PERSPECTIVE - It is impossible to earn higher returns on a regular basis without incurring higher risk - However, we CAN construct well-diversified portfolios that are expected to earn higher returns that the market - Of course, such a portfolio will have high risk (beta) - There’s technically no undervalued company in the market - You have to take a higher risk to beat the market, but it is possible - More systematic risk HOW CAN WE HOLD THE MARKET AND STILL BEAT IT? - Some of the most recent innovations in financial products are levered exchange traded funds, which trade like one stock and deliver the returns of two or three times the market index - You can buy penny stocks, but there is no reason to hold only a few stocks you think will outperform LIMITATIONS TO MARKET EFFICIENCY MARKET ANOMALIES AND OPPORTUNITIES PSYCHOLOGICAL BIASES: DISPOSITION EFFECT - Investors are quick to realize profits from winning stocks, but tend to hold losers too long, hoping that these stocks will recover - As a result, investors delay selling their underperforming stocks in response to bad news - This practice, called the disposition effect, is well-documented for both individual and institutional investors Disposition Effect - investors are not efficie
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