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Chapter 17
Capital Market Efficiency
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 17–1
Prepared by Dr Buly Cardak
Learning Objectives
• Understand the concept of market efficiency.
• Distinguish between different categories of market efficiency.
• Understand the methods used to test for market efficiency.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 17–2
Prepared by Dr Buly Cardak
Learning Objectives (cont.)
• Understand the major trends in tests of market efficiency that have uncovered evidence that is ‘anomalous’ from a market efficiency viewpoint.
• Understand the implications of the developing field of behavioural finance for the efficient market hypothesis.
• Understand the implications of market efficiency for investors and financial managers.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 17–3
Prepared by Dr Buly Cardak
Efficient Market Hypothesis (EMH)
• ‘EMH’: that the price of a security (such as a share) accurately reflects all available information.
• If the market processes new information efficiently, the reaction of market prices to new information will be instantaneous and unbiased.
• The concept of efficient markets with respect to information was introduced by Fama (1970).
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 17–4
Prepared by Dr Buly Cardak
A Non-Instantaneous Price Reaction
• An instantaneous price reaction would, in practice, mean that after new information becomes available it should be fully reflected in the next price established in the market.
• If the market often fails to react instantaneously, share traders can develop simple rules to generate excess profits.
– Simply purchase shares immediately after a company makes an unanticipated announcement of good news.
– If the reaction is not instantaneous, a positive profit will be earned.
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 17–5
Prepared by Dr Buly Cardak
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