bkmsolch119e corrected 729.docx

1、bkmsolch119e corrected 729CHAPTER 11: THE EFFICIENT MARKET HYPOTHESISPROBLEM SETS 1. The correlation coefficient between stock returns for two non-overlapping periods should be zero. If not, one could use returns from one period to predict returns in later periods and make abnormal profits. 2. No. M

2、icrosofts continuing profitability does not imply that stock market investors who purchased Microsoft shares after its success was already evident would have earned an exceptionally high return on their investments.3. Expected rates of return differ because of differential risk premiums.4. No. The v

3、alue of dividend predictability would be already reflected in the stock price.5. No, markets can be efficient even if some investors earn returns above the market average. Consider the Lucky Event issue: Ignoring transaction costs, about 50% of professional investors, by definition, will “beat” the

4、market in any given year. The probability of beating it three years in a row, though small, is not insignificant. Beating the market in the past does not predict future success as three years of returns make up too small a sample on which to base correlation let alone causation.6. Volatile stock pri

5、ces could reflect volatile underlying economic conditions as large amounts of information being incorporated into the price will cause variability in stock price. The Efficient Market Hypothesis suggests that investors cannot earn excess risk-adjusted rewards. The variability of the stock price is t

6、hus reflected in the expected returns as returns and risk are positively correlated.7. The following effects seem to suggest predictability within equity markets and thus disprove the Efficient Market Hypothesis. However, consider the following: a. Multiple studies suggest that “value” stocks (measu

7、red often by low P/E multiples) earn higher returns over time than “growth” stocks (high P/E multiples). This could suggest a strategy for earning higher returns over time. However, another rational argument may be that traditional forms of CAPM (such as Sharpes model) do not fully account for all r

8、isk factors which affect a firms price level. A firm viewed as riskier may have a lower price and thus P/E multiple. b. The book-to-market effect suggests that an investor can earn excess returns by investing in companies with high book value (the value of a firms assets minus its liabilities divide

9、d by the number of shares outstanding) to market value. A study by Fama and French suggests that book-to-market value reflects a risk factor that is not accounted for by traditional one variable CAPM. For example, companies experiencing financial distress see the ratio of book to market value increa

10、se. Thus a more complex CAPM which includes book-to-market value as an explanatory variable should be used to test market anomalies. c. Stock price momentum can be positively correlated with past performance (short to intermediate horizon) or negatively correlated (long horizon). Historical data see

11、m to imply statistical significance to these patterns. Explanations for this include a bandwagon effect or the behavioralists (see Chapter 12) explanation that there is a tendency for investors to underreact to new information, thus producing a positive serial correlation. However, statistical signi

12、ficance does not imply economic significance. Several studies which included transaction costs in the momentum models discovered that momentum traders tended to not outperform the Efficient Market Hypothesis strategy of buy and hold. d. The small-firm effect states that smaller firms produce better

13、returns than larger firms. Since 1926 returns from small firms outpace large firm stock returns by about 1% per year. Do small cap investors earn excess risk-adjusted returns? The measure of systematic risk according to Sharpes CAPM is the stocks beta (or sensitivity of returns of the stock to marke

14、t returns). If the stocks beta is the best explanation of risk, then the small-firm effect does indicate an inefficient market. Dividing the market into deciles based on their betas shows an increasing relationship between betas and returns. Fama and French show that the empirical relationship betwe

15、en beta and stock returns is flat over a fairly long horizon (1963-1990). Breaking the market into deciles based on sizes and then examining the relationship between beta and stock returns within each size decile exhibits this flat relationship. This implies that firm size may be a better measure of

16、 risk than beta and the size-effect should not be viewed as an indicator that markets are inefficient. Heuristically this makes sense, as smaller firms are generally viewed as risky compared to larger firms and perceived risk and return are positively correlated. In addition this effect seems to be

17、endpoint and data sensitive. For example, smaller stocks did not outperform larger stocks from the mid 1980s through the 1990s. In addition, databases contain stock returns from companies that have survived and do not include returns of those that went bankrupt. Thus small-firm data may exhibit surv

18、ivorship bias.8. Over the long haul, there is an expected upward drift in stock prices based on their fair expected rates of return. The fair expected return over any single day is very small (e.g., 12% per year is only about 0.03% per day), so that on any day the price is virtually equally likely t

19、o rise or fall. Over longer periods, the small expected daily returns accumulate, and upward moves are more likely than downward ones.9. c. This is a predictable pattern in returns which should not occur if the weak-form EMH is valid.10. a. Acute market inefficiencies are temporary in nature and are

20、 more easily exploited than chronic inefficiencies. A temporary drop in a stock price due to a large sale would be more easily exploited than the chronic inefficiencies mentioned in the other responses.11. c. This is a classic filter rule which should not produce superior returns in an efficient mar

21、ket.12. b. This is the definition of an efficient market.13. a. Though stock prices follow a random walk and intraday price changes do appear to be a random walk, over the long run there is compensation for bearing market risk and for the time value of money. Investing differs from a casino in that

22、in the long-run, an investor is compensated for these risks, while a player at a casino faces less than fair-game odds. b. In an efficient market, any predictable future prospects of a company have already been priced into the current value of the stock. Thus, a stock share price can still follow a

23、random walk. c. While the random nature of dart board selection seems to follow naturally from efficient markets, the role of rational portfolio management still exists. It exists to ensure a well-diversified portfolio, to assess the risk-tolerance of the investor and to take into account tax code i

24、ssues.14. d. In a semistrong-form efficient market, it is not possible to earn abnormally high profits by trading on publicly available information. Information about P/E ratios and recent price changes is publicly known. On the other hand, an investor who has advance knowledge of management improve

25、ments could earn abnormally high trading profits (unless the market is also strong-form efficient).15. Market efficiency implies investors cannot earn excess risk-adjusted profits. If the stock price run-up occurs when only insiders know of the coming dividend increase, then it is a violation of str

26、ong-form efficiency. If the public also knows of the increase, then this violates semistrong-form efficiency.16. While positive beta stocks respond well to favorable new information about the economys progress through the business cycle, they should not show abnormal returns around already anticipat

27、ed events. If a recovery, for example, is already anticipated, the actual recovery is not news. The stock price should already reflect the coming recovery.17. a. Consistent. Based on pure luck, half of all managers should beat the market in any year.b. Inconsistent. This would be the basis of an “ea

28、sy money” rule: simply invest with last years best managers.c. Consistent. In contrast to predictable returns, predictable volatility does not convey a means to earn abnormal returns.d. Inconsistent. The abnormal performance ought to occur in January when earnings are announced.e. Inconsistent. Reve

29、rsals offer a means to earn easy money: just buy last weeks losers.18. The return on the market is 8%. Therefore, the forecast monthly return for Ford is:0.10% + (1.1 8%) = 8.9%Fords actual return was 7%, so the abnormal return was 1.9%.19. a. Based on broad market trends, the CAPM indicates that Am

30、bChaser stock should have increased by: 1.0% + 2.0 (1.5% 1.0%) = 2.0%Its firm-specific (nonsystematic) return due to the lawsuit is $1 million per $100 million initial equity, or 1%. Therefore, the total return should be 3%. (It is assumed here that the outcome of the lawsuit had a zero expected val

31、ue.)b. If the settlement was expected to be $2 million, then the actual settlement was a “$1 million disappointment,” and so the firm-specific return would be 1%, for a total return of 2% 1% = 1%.20. Given market performance, predicted returns on the two stocks would be:Apex: 0.2% + (1.4 3%) = 4.4%B

32、pex: 0.1% + (0.6 3%) = 1.7%Apex underperformed this prediction; Bpex outperformed the prediction. We conclude that Bpex won the lawsuit.21. a. E(rM ) = 12%, rf = 4% and = 0.5Therefore, the expected rate of return is:4% + 0.5 (12% 4%) = 8%If the stock is fairly priced, then E(r) = 8%.b. If rM falls short of your expectation by 2% (that is, 10% 12%) then you would expect the return for Changing Fortunes Industries to fall short of your original expectation by: 2% = 1%Therefore, you would for