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The effective market hypothesis
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, 1: (ii) A researcher has analysed the annual returns of equity stocks in a
particular
country over a 10-year period and has made the following observations:
(a) Annual market returns in consecutive years have a negative correlation of
?0.25.
(b) The closing value of the index of the 100 stocks with the highest market
capitalisation has been found to be 1% higher on average on Fridays than
on Mondays.
(c) Announcements of changes in company?s dividend policies typically
take
three months to become fully reflected in the quoted share price.
(d) The prices of a particular subset of stocks have been consistently
observed to fall immediately following a favourable announcement and
to rise immediately following an unfavourable announcement.
Discuss these observations in the light of the EMH. [4]
[Total 6]
(ii)
Discuss the observations
(a)
Annual market returns are negatively correlated
This observation suggests that, over annual time periods, the market tends to
systematically overreact to new information and hence that the market may
not be semistrong form efficient.
In addition, trading rules could be developed based on this information that
could
generate excess, risk-adjusted returns, which suggests that this observation is
inconsistent with the weak form of the EMH.
(b) The index is higher on Fridays than on Mondays
The observation suggests that there is a consistent tendency for prices on
Fridays to be
?inflated?, while prices on Mondays are ?depressed?, ie there is a systematic
bias
present in the prices.
Trading rules could be developed based on this information (eg buy on
Monday, sell on
Friday) that could generate excess, risk-adjusted returns, which suggests that
this
observation is inconsistent with the weak form of the EMH.
(c) Announcements take three months to be reflected
If the semi-strong form of the EMH holds, public dividend announcements
should have
an immediate effect on the share prices as the market should respond quickly
and
accurately to new information.
This observation suggests that the market is not semi-strong form efficient.
The effective market hypothesis
Buy and sell summaries, lecture notes, practice exams and other
study documents or get support from other students who want to
help you with your studies.
Downloaded by: 1037795 -
This document is protected by copyright, the distribution of this document is illegal.
, 1: (ii) A researcher has analysed the annual returns of equity stocks in a
particular
country over a 10-year period and has made the following observations:
(a) Annual market returns in consecutive years have a negative correlation of
?0.25.
(b) The closing value of the index of the 100 stocks with the highest market
capitalisation has been found to be 1% higher on average on Fridays than
on Mondays.
(c) Announcements of changes in company?s dividend policies typically
take
three months to become fully reflected in the quoted share price.
(d) The prices of a particular subset of stocks have been consistently
observed to fall immediately following a favourable announcement and
to rise immediately following an unfavourable announcement.
Discuss these observations in the light of the EMH. [4]
[Total 6]
(ii)
Discuss the observations
(a)
Annual market returns are negatively correlated
This observation suggests that, over annual time periods, the market tends to
systematically overreact to new information and hence that the market may
not be semistrong form efficient.
In addition, trading rules could be developed based on this information that
could
generate excess, risk-adjusted returns, which suggests that this observation is
inconsistent with the weak form of the EMH.
(b) The index is higher on Fridays than on Mondays
The observation suggests that there is a consistent tendency for prices on
Fridays to be
?inflated?, while prices on Mondays are ?depressed?, ie there is a systematic
bias
present in the prices.
Trading rules could be developed based on this information (eg buy on
Monday, sell on
Friday) that could generate excess, risk-adjusted returns, which suggests that
this
observation is inconsistent with the weak form of the EMH.
(c) Announcements take three months to be reflected
If the semi-strong form of the EMH holds, public dividend announcements
should have
an immediate effect on the share prices as the market should respond quickly
and
accurately to new information.
This observation suggests that the market is not semi-strong form efficient.
