week 2

• Efficient Market Hypothesis (EMH)


  Hypothesis that market prices fully reflect all available information
• Forms of EMH


  • Weak form
  • Semi-strong form
  • Strong form
• Weak form EMH


  • Prices reflect the information contained in the record of past prices
  • Impossible to make consistently superior profits by studying past returns
  • Prices should follow a random walk
• Semi-strong form EMH


  • Prices reflect not just past prices but all other public information
  • Prices will immediately adjust to public information
• Strong form EMH


  • Prices reflect all the information that can be acquired by painstaking analysis of companies and the economy
  • Even inside information cannot enable an investor to beat the market
  • Should observe lucky and unlucky investors
  • No superior investment managers who consistently beat the market
• Empirical evidence on EMH shows difficulty of beating the market consistently and rapid information diffusion
• Empirical evidence also shows anomalies and contradictions to EMH such as size, value, and momentum effects, and excess volatility
• Behavioural finance


  Discipline that challenges the assumption of human rationality in modern economic theory
• Behavioural biases


  • Herding behaviour
  • Overconfidence
  • Prospect theory (risk aversion in gains, risk seeking in losses, loss aversion, endowment effect, disposition effect)
• Behavioural biases can lead to market inefficiencies
• Combining quantitative signals with fundamental insights can help investment professionals exploit market inefficiencies
• Both efficient market and behavioural finance are correct but not perfect
• It is hard to systematically beat the market, but possible to exploit inefficiencies