RSM332 Final notes.docx

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Rotman Commerce
William Huggins

APT o Cancelled by transaction costs, ad risky because they do not  Arbitrage Pricing Theory (APT) is a factor-based model of expected returns, occur all the time much like the CAPM but with fewer restrictions. Semi- Strong EMH  No need to talk about investor utility or risk aversion  Semi-strong form EMH is the theory that all publicly known and available  No need to find a proxy for the “market portfolio”, nor is everyone information is reflected in security prices predicted to own it  Assumes the weak-form set of information as well as all public information  CAPM can be considered a special case of APT. pertinent to the security such as: earnings, dividends, corporate investments, What makes good risk factors? management changes  Its variations should affect a large amount (if not all) of the stocks unde If semi-strong efficient, it is futile to analyze public information such as earnings consideration. projections and financial statements in an attempt to identify underpriced or  Its impact on prices should come from its unpredictable changes overpriced securities  The risks should be un-diversifiable (generally they will be macroeconomic  Tests: Events studies, Examination of performance investors variables)  Stock price actually go up before the announcement  supports semi-  Accurate and timely information must be available (or you won’t be able strong EMH, but not strong EMH to test the relationship)  Anomalies and (counter arguments) Conditions to meet efficient market: o Earning surprises, their substantial adjustment after the  A large number of rational, profit-maximizing investors exist, who actively announcement date contradicts semi-strong EMH participate in the market by analyzing, valuing, and trading securities. The markets o Value vs. growth stocks (value could outperform growth stock) must be competitive, meaning no one investor can significantly affect the price of o Size effect (performance fluctuates, and higher trading costs in the security through their own buying or selling. smaller caps)  Info is costless and widely available to market participants at the same time. o Survey by Value Line Inc. (trading costs, and market adjusts  Information arrives randomly(unpredictably) and therefore announcements over quickly to new information) time are not serially connected. Strong form EMH  Investors react quickly and fully (and reasonably accurately) to the new  Strong form EMH is the theory that stock prices fully reflect all information, which information, which is reflected in stock prices. includes both public and private information Efficient Market Hypothesis  Stock prices are fairly priced.  An efficient market is a market that reacts quickly and relatively accurately to  It is not possible to use public and insider information to identify over- new public information, which results in prices that are, on average, correct. priced or under-priced stocks  The efficient market hypothesis is the theory that markets are efficient and Conclusion and Implications therefore, in its strictest sense, implies that prices accurately reflect all availaEmpirical Evidence suggests: information at any given time  Markets generally react quickly and relatively accurately to new public Weak form EMH information  Weak form EMH is the theory that security prices reflect all market data, referrin Market prices are thus correct on average to all past price and volume trading information  This implies that market prices can be “incorrect” and empirical evidence  If weak form efficient, historical trading data will already be reflected (discounted) suggests mispricing can last for a long time. in current prices and should be of no value in predicting future price changes  Importantly, these conclusions are based on the population mean, not every  The Random Walk Hypothesis states prices follow a rand
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