Efficient Markets

Efficient Markets

1. Essence: Price of a financial asset reflects all available information that is relevant to its value

2. Financial engineering: designed derivatives and securitisations, making the financial system safer and the economy helthier

3. 2007: Financial crisis. Blow to the credibility.

   • 1987: Stock market crash

4. EMH: Effiency market hypothesis. Black scholes formula (pricing options)

   • Markets tend to return prices-efficient equilibrium-continuing relevance of EMH

5. LTCM: Long term capital management (hedge fund, pointing out dangers ignored)

6. VAR: Value at risk. To work out how much capital they need to set aside as insurance against losses.

   • Mistakenly assume volatility of asset prices and the correlations between prices are constant
     • Scholes: lees on VAR, each category of asset should have its own risk capital reserves.

7. Institutional frictions: Smart investors would be able to trade against less well informed noise traders

   • Rational inestors may contribute to bubbles rather than presenting them.

8. Behavioural economics: human tend to be too confident of their own abilities.

   • Stock market bubbles-affect prices

9. Adaptive markets hypothesis: best guesses and by trials and error

10. Uncovered-interest parity Theory

    • The forward rate in the currency market was the best predictor of exchange-rate movement

11. Anomalies that cannot be explained

    • Momentum effect
      • shares that have outperformed the market in the recent past continue to do so
        • Emerged the smart beta
          • Possibility 1
            • The anomalies are statistical quirks
          • Possibility 2
            • The excess returns are compensation for risk
          • Possiblity 3
            • The returns reflect some quirk of behaviour
    • low-volatility effect
      • shares that move less violently than the market produce better risk adjusted returns

12. The battle of efficient markets

    • Nasdaq the second biggest stock market in the world
      • Nasdaq market quickly became known as the place where America´s promise growht companies went to raise equity
    • New York Stock Excange, the biggest in the world
      • most of these failing is that the NYES has refuse to adapt as markets have evolve
        • NYES´s chief excecutive is not complacent about the current prosperity. He said that the board is vulnerable
          • They have plan to build a new floor accross the streer in lower manhattan to seem to have come unstuck
            • Mr Grasso himself admits only to concern that the visual imagen of the floor may not send the reight message to the world.
    • the SEC is consulting on proposal to create a system that would integrate trading information from America´s separete exchanges
      • the great competitive advantage of NYSE is the liquidity, on the other hand there are no specialist in the nasdaq stock exchange
        • Schwab is a big consumer of the NYSE data, if the big board does start to make more of it´s data, however, the users of the NYSE, might themselves want to be compensated.
          • As the masrketplace globalises, it´s surely not going to be enought. the only way in which it might work is if all the world´s biggest companies were to come to the big board, but there is a little chance of that happening.