EMH

EMH

1. Weak

   • - Prices reflect all historical data - Fundamental Analysis is useless
   • Tests:
     • 2. Tests of Trading Rules - Use only publicly available data, includes all transactions cost, adjusted results for risks - Only better-known technical trading rules examined
       • Tests' results generally support EMH, but are not unanimous
     • 1. Statistical Tests of Independence - Autocorrelation tests - Runs tests
       • Tests' results generally support EMH, but are not unanimous

2. SemiStrong

   • - Prices reflect all historical data and public info - Fundamental and Technical Analysis is useless
   • Tests:
     • 1. Time series analysis for either - ROR, or -cross-section distribution of returns for individual stocks.
       • Firm size emerged as a major predictor of future ROR - an anomaly in EMHs literature Attempts to explain the Size anomaly* have not succeeded
     • 2. Event studies that examine how fast stock prices adjust to specific significant economic events.
       • Strong support from numerous event studies (with the exception of Exchange Listing studies)

3. Strong

   • - Prices reflect all historical data, private and public info - Insider Info, Fundamental and Technical Analysis is useless
   • Tests
     • Corporate Insiders
       • - After transaction costs, following insider trading will not be generally profitable for public investors (according to pre-2006 studies) However, can increase returns by using insider trading information with key financial ratios
     • Securities Analysts
       • - Evidence FOR superior analysts who have private info - Analysts seem to have market timing and stock-picking ability - The most useful information consisted of upward earning revision
     • Money Managers
       • the overall results indicate, at best, some weak support for strong-form EMH

4. Implications for investors

   • Tech Analysis
     • develop systems to detect movement towards a new equilibrium (breakout); trading is based on that new equilibrium
       • If market is weak EMH, historical data is useless
   • Fund Analysis
     • Agg Market Analysis
       • must estimate relevant variables that cause long-run movements
     • Industry and Company Analysis
       • Do a superior job of estimating future values of relevant valuation variables, not just look at past data
   • Portfolio Mgt
     • W/ superior analysts
       • - Concentrate efforts in mid-cap stocks that that get less attention vs. top-tier stocks - mid-cap stocks' may be less efficient vs large well-known stocks
     • W/o superior analysts
       • - Determine and quantify risk preferences - Construct the appropriate portfolio - Diversify completely on a global basis to eliminate all unsystematic risk - Maintain desired risk level by rebalancing the portfolio when necessary - Minimize total transaction costs

5. Behavioural Finance

   • 3 Main tributaries: psychology, social Pyschology, neuro-finance
   • Explaining Biases
     • Prospect Theory
     • Overconfidence
     • Escalated Commitment
     • Noise Treaders
   • Fusion Investing
     • - Integraing 1. valuation-fundamental value and 2. investor sentiment - In some periods, investor sentiment is muted and noise traders are inactive so fundamental valuation dominates market returns - In other periods when investor sentiment is strong, noise traders are very active so market returns are more heavily impacted by investor sentiments