Question

For nearly 60 years, a now defunct but once prominent Wall 100Street firm has chosen every year 10 stocks which it feels will outperform the market over the
next twelve months. In its promotional material, the firm writes:

“In its history, Lehman Brothers’ 10 Uncommon Values⃝r has [sic] beaten the S&P 500 over 73% of the time, delivering a 15.4% average annual return vs. 8.9% for the S&P. Last year, the 10 Uncommon Values⃝r returns on the portfolio declined 41.2% vs. a 46.2% decline for the Nasdaq, and 16.5% for the S&P 500. However, in its 52-year history, after the occasional down year, the average annual return for the portfolio has been 39.8% vs. 19.1% for the S&P in those same years” (www.lehman.com/equities/10uv/index.htm, October 2001).

Intrigued by the apparent success of this portfolio, you collect the relevant data and run a (highly significant) regression of the TUV annual returns on the S&P 500 annual returns of the form

RTUV,t =α+βTUVRS&P,t+εt

to find that RTUV,t = 0.0367 + 1.4649RS&P,t. You also calculate the respective standard deviations of the annual returns as σTUV = 27.36% and σS&P = 15.84%; the average return on US T-bills was about 3.80% per annum in the last 60 years.

1. (a) Define what is meant by efficient capital markets and state the three forms of market efficiency.

2. (b) How does one assess whether capital markets are efficient? Explain at least two approaches to investigate informational efficiency of capital markets.

3. (c) What is academic evidence on market efficiency. Which form, if any, is thought to hold in practice? Which form, if any, might not?

4. (d) Compute the Sharpe and Reward-to-Risk ratios for both the TUV and S&P 500 returns. Do the TUV returns still look as good after the risk-adjustment when compared to the S&P 500?

5. (e) How can you reconcile your findings above with market efficiency?

6. (f) Many developed equity markets are deemed to be informationally efficient. What economic forces lead to market efficiency? How can one ensure that they can properly operate?

Answer 1

a. Market efficiency refers to the extent to which market prices reflect available, relevant information. If markets are efficient, all the information is already incorporated into the prices, so there is no way to “beat” the market because there are fewer or more exaggerated securities available.

There are three degrees of market efficiency.

A weak way of market efficiency

The dynamic nature of market efficiency

A strong form of market efficiency

b. From an international macro point of view, you check the correlation of domestic investment and national savings. Beta takes between 0-1. In the case of 1, there is full capital market efficiency, because price 1 is an indicator of full capital consciousness.

Exposure to security is the basis for making an investment decision. There are three theoretical approaches to calculating market value, namely, baseline analysis, technical analysis and effective market insights. In a basic way, a security analyst or potential investor is interested in analyzing factors such as economic influence, industry structures and company-related information such as product demand, earnings, dividends, and management, in order to calculate the ambiguous value of a company's firm. to avoid. It comes to a decision to invest by comparing this price to the current market price of security. Technical analysts or brides, as they are commonly called, believe that they can detect patterns in price movements or volumes, and by observing and studying the behavior patterns in given stocks, they can use this accumulated historical information to predict future price movements for security. Technical analysis covers many different ways of conceptualizing, but they all have one thing in common - the belief that these previous movements are very useful in predicting future movements. Market efficiency means that all known information is quickly discounted by all investors and reflected in stock market prices. As it is, no one has the edge of knowledge. In other words, it is the degree to which stock prices reflect all available, relevant information. As such, no one has the edge of knowledge, in an efficient market; everyone knows all the possible information at one time, interprets it and behaves in a human way.

c. Although the hypothesis of a functioning market as a whole ensures that the market is efficient, the idea is said to be in three different types: weak, strong, and strong.

The basic efficient market hypothesis states that the market cannot be beaten because it incorporates all the important deterministic information into current share prices. Therefore, the sale of shares at fair value, meaning that it cannot be bought for less or sold is limited.

The opinion determines that the only investment investors should be able to achieve is high returns on their investment in a risky investment.

e. Market efficiency can be estimated using different tests, each with its own strengths. One tested test phase is to see if it is possible to achieve an unusual return based on past inflation. In fact, if you can use many strategies to 'beat the market', that can be interpreted as a low level of market efficiency.

f. When people talk about market efficiency, they refer to the degree to which the collective decisions of all market participants accurately reflect the number of public companies and their ordinary shares at any given time. This requires determining the company's unique value and regularly updating that recognition as new information becomes known. The fastest and most accurate market is the ability to sell securities, and when it is effective.
There are several versions of EMH that determine how strong the guesswork needed to hold. However, this view has its own guerrillas, who believe that the market is economically volatile, which results in stocks being too liberalized or subsidized, and they have their historical data to support it.

For example, consider the boom (and subsequent rust) of the dot-com bubble in the late 1990s and early 2000s. Countless tech companies (many of whom had never turned a profit) are being driven to ridiculous price levels by the mass market. It was a year or two before the bubble hit, or the market corrected itself, which could be seen as evidence that the market was completely dysfunctional - at least, not all that time.

In fact, it is not uncommon for a given stock to experience a high spike in a short period of time, but then back down (sometimes even on the same trading day). Of course, these types of price movements do not fully support efficient market agreement.