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03 - Market Efficiency

The document discusses market efficiency and different forms of the market efficiency hypothesis. It explains weak, semi-strong, and strong forms of the hypothesis and whether they are supported by empirical evidence. It also provides an example of the 2008 financial crisis to illustrate how market efficiency can break down.

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16 views16 pages

03 - Market Efficiency

The document discusses market efficiency and different forms of the market efficiency hypothesis. It explains weak, semi-strong, and strong forms of the hypothesis and whether they are supported by empirical evidence. It also provides an example of the 2008 financial crisis to illustrate how market efficiency can break down.

Uploaded by

arp140102
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Instructor: Beatriz Balbás Aparicio

[email protected]

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013
CONTENTS
1. Financial Markets
2. Financial instruments: fixed income, equity and
derivatives
3. Market Efficiency

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 2
1. Efficient market concept

"An efficient market is a fair game in which all


investors have an equal chance of winning
or losing."

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 3
 An efficient market is one in which an investor cannot
obtain extraordinary long-term or systematic returns
beyond those generated by the market.

 To beat the market in the long term, you have to assume a


greater risk, and therefore you have to be willing to lose
more than the market.

 "It is a market that cannot be beaten"

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 4
 Why is the market unbeatable?
 There is a model in Financial Economics (CAPM) that shows
that it is very easy to invest and earn the same as the market.

 If someone wins more systematically, it means that someone


is winning less systematically.

 Which implies that an inefficient market could exist if many


of its participants were extraordinarily naive.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 5
2. Versions and interpretations of the
Market Efficiency Hypothesis
 "Market efficiency hypothesis"
 This hypothesis can manifest itself in different ways.

 Each form has different implications for the functioning of


markets.

 Weak form of the market efficiency hypothesis


 Semi-strong form of the market efficiency hypothesis
 Strong form of the market efficiency hypothesis

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 6
 Weak form of the market efficiency hypothesis

 “The returns on a financial asset in periods that do not overlap are


independent random variables.”
 EXAMPLE: The variation and profitability of the IBEX 35 yesterday
is independent of the variation and profitability of the IBEX 35
today.
 "The Stock Market has no memory."
 There is no independence in levels (in what we win / lose).

 Why is this efficiency?

 Because I cannot beat the market by predicting its behavior based on what
it has done recently.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 7
 Semi-strong form of the market efficiency hypothesis

 Markets value well, in the sense that they use all available public
information.
 Asset prices are consistent with all information made public and no
better than market performance can be achieved using such
information.
 EXAMPLE: The price that Telefónica gives you is the good one and
you cannot beat it.
 Fundamental analysis techniques will not be able to outperform the
market.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 8
 Strong form of the market efficiency hypothesis

 The prices of financial assets include even privileged and


confidential information.

 Asset prices reflect all information, and no one can


outperform the market.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 9
 Contrast of the 3 versions: Do they work?

 The strong version is not true in general. It is not supported by


empirical experience.
 It has been observed that there are agents who obtain higher
returns using private information.
 EXAMPLE: Studies in the US market show that speculating using this type of
information is relatively common.
 Another thing very different is that this is systematic and relevant: Inside
information is usually made public.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 1
 The semi-strong version is true in general, although
there are some imperfections.

 There are experts who analyze financial assets and


companies very well and then find imbalances and take
advantage of them, but by taking advantage of them they
undo the possitions.

 EXAMPLE: People who see undervalued things can buy them,


overvalued they can sell them.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 11
 The weak version is true. Especially when taking
periods longer than 3 days.

 If weekly correlations are taken, zero correlation (independence)


almost always occurs.
 When it is not zero, the serial correlation occurs, for example,
day by day.

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 12
EXAMPLE: ORIGINE OF FINANCIAL CRISIS IN 2008
 Despite all the regulations and agencies out there, we all know the financial
crisis that has occurred.
 Origin: USA, but it spread quickly.
 Major cause: real estate speculation.
 Bonds were issued to give mortgages (banks were financed through Fixed
Income to grant loans to individuals). Seeing that a lot of money was being
made from bonds, very complicated derivative products were created.

 The banks thought: "If they don't pay me the mortgage, I'll take the house from
them, sell it and get the money back."

 What they did not realize is that the price of houses fell down a lot caused by a
tremendous drop in demand. (The price of houses went up considerably, due to
the high demand that was in the beginning. This made people no longer able to
pay for them and they began to return them to the bank, consequence: people
stop buying houses → demand decreases so price also decreases).
 So, the banks did not have enough money to pay their debts.
Instructor: Beatriz Balbás Aparicio
I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 13
 HOW IS IT SOLVED?

 With capital requirements.


 Higher supervision.

 All this has questioned the efficiency of the markets.

 Semi-strong hypothesis has not been fulfilled.

 Much mistrust is generated (no credit): increased


unemployment, no consumption, companies continue to
lose money...: the economy collapses.
Instructor: Beatriz Balbás Aparicio
I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 1
 Interesting video about Market Efficiency:

https://www.youtube.com/watch?v=bM9bYOBuKF4

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013 15
Instructor: Beatriz Balbás Aparicio
[email protected]

Instructor: Beatriz Balbás Aparicio


I.S.B.N: 978-84-695-9456-8
DEPÓSITO LEGAL: M-36714-2013

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