Limited of arbitrage Arbitrage plays a critical role in the analysis of securities markets because its effect is to bring prices to fundamental values and to keep market to efficient In practice the arbitrageurs are of capital constrained, and their effectiveness in bring prices to fundamental values is limited
Limited of arbitrage • Arbitrage plays a critical role in the analysis of securities markets, because its effect is to bring prices to fundamental values and to keep market to efficient. • In practice, the arbitrageurs are of capital constrained, and their effectiveness in bring prices to fundamental values is limited
Mutual fund performance equity funds: on average, active managers underperform index funds when both are measured after expenses, and those that do outperform in one-period are not typically the ones who outperform in the next Fixed-income funds on average bond funds underperform passive fixed -income indexes by an amount roughly equal to expense, and there is no evidence that past performance can predict future performance
Mutual fund performance • Equity funds: on average, active managers underperform index funds when both are measured after expenses, and those that do outperform in one-period are not typically the ones who outperform in the next. • Fixed-income funds: on average, bond funds underperform passive fixed-income indexes by an amount roughly equal to expense, and there is no evidence that past performance can predict future performance
Anomalies · The size effects The value effect The short-term momentum The long-term reversal The new issues puzzle The January effect
Anomalies • The size effects • The value effect • The short-term momentum • The long-term reversal • The new issues puzzle • The January effect…
The bottom line The efficient market hypothesis is a useful framework for modeling financial markets Like any model, the efficient market hypothesis is not a perfect description of reality; some prices are almost certainly wrons However, it would be naive to think that prices are al ways wrong or that it is easy to exploit pricing errors Instead of asking whether or not the market is efficient, the more relevant questions are -how efficient is the market? ---how does the market react to new information arrivals? And why? c--what are the mechanisms that bring market prices to fundamental values?
The bottom line • The efficient market hypothesis is a useful framework for modeling financial markets. • Like any model, the efficient market hypothesis is not a perfect description of reality; some prices are almost certainly “wrong”. • However, it would be naïve to think that prices are always wrong or that it is easy to exploit pricing errors. • Instead of asking whether or not the market is efficient, the more relevant questions are: • ---how efficient is the market? • ---how does the market react to new information arrivals? And why? • ---what are the mechanisms that bring market prices to fundamental values?
Event studies Impact of "event on security prices Earning announcement; stock split; block trade; merger announcement; regulatory change Need a model of“ normal or“ expected returns constant mean market model: multifactor models abnormal returns=Actual-normal study abnormal returns: moments cumulative abnormal returns statistical inference
Event studies • Impact of “event” on security prices: • Earning announcement; stock split; block trade; merger • announcement; regulatory change. • Need a model of “normal” or “expected” returns: • constant mean; market model; multifactor models. • Abnormal returns=Actual-Normal • study abnormal returns: moments • cumulative abnormal returns • statistical inference. •