Deck 10: Concepts and Applications of Market Efficiency

Question 1

According to Black (1986),informed traders are most unlikely to trade on 'noise'.

Answer 1

True
Explanation: As uninformed traders do not trade on specific pieces of information,they can drive prices away from fundamental values.Black (1986)terms such price movements as noise.The presence of noise allows informed traders to enter the market and make profits from trading on information that is not reflected in the noise in prices.

Question 2

One misconception about market efficiency is that:

Answer 2

C
Explanation: There are several widely held misconceptions in relation to market efficiency.First,efficiency does not imply predictability of prices.Indeed,it is inefficiency that implies predictability.Prices in an efficient market reflect available information.Prices change as new information arrives.Second,efficiency does not imply that prices are set in a random fashion.In an efficient market,prices are set relative to the current information set.Third,frequent price movements of varying magnitude can be consistent with an efficient market.If the rate of new information arrival is high and this information implies variations in prices,then it is expected that price changes would be frequent and of varying magnitude.Indeed,if such price variations were not observed,then market efficiency would be questioned.Fourth,expected return does not imply actual return.Fifth,investors will not all perform equally.In a large sample,a degree of variation is expected.Some investors will win and some investors will lose.Finally,the financial press often refers to a market correction,a realignment or a downgrade due to price levels having reached a peak.That is,what goes up must come down.This is another fallacy.The efficient markets hypothesis simply claims that prices fully reflect available information.

Question 3

Which of the following is a misconception of market efficiency?

Answer 3

A
Explanation: There are several widely held misconceptions in relation to market efficiency.First,efficiency does not imply predictability of prices.Indeed,it is inefficiency that implies predictability.Prices in an efficient market reflect available information.Prices change as new information arrives.Second,efficiency does not imply that prices are set in a random fashion.In an efficient market,prices are set relative to the current information set.Third,frequent price movements of varying magnitude can be consistent with an efficient market.If the rate of new information arrival is high and this information implies variations in prices,then it is expected that price changes would be frequent and of varying magnitude.Indeed,if such price variations were not observed,then market efficiency would be questioned.Fourth,expected return does not imply actual return.Fifth,investors will not all perform equally.In a large sample,a degree of variation is expected.Some investors will win and some investors will lose.Finally,the financial press often refers to a market correction,a realignment or a downgrade due to price levels having reached a peak.That is,what goes up must come down.This is another fallacy.The efficient markets hypothesis simply claims that prices fully reflect available information.

Question 4

Figure 10.6,page 334,shows Beedles,Dodd and Officer's (1988)study.The authors find that Australian small firms have risk-adjusted returns of around 8% p.a.
Joe bought a stock at $57 per share.The price promptly fell to $55.Joe held on to the stock until it again reached $57,and then he sold it once he had eliminated his loss.If other investors do the same to establish a trading pattern,this would contradict _______.

A)the strong form
B)the weak form
C)technical analysis
D)the semi-strong form

Question 5

The group of investors who trade because of a surplus or need for cash are called:

Question 6

Economy wide announcements such as those about money supply tend to create a large amount of market reaction.

Question 7

In Australia,share returns are at their highest in both January and July and their lowest in June (Brown,Keim,Kleidon and Marsh 1983,Brailsford and Easton 1991).In New Zealand,share returns exhibit a large positive spike in January and April (Brailsford 1993).The abnormally high January return is also present in the Asian markets such as Singapore (Gultekin and Gultekin 1983).Figure 10.2,page 323,plots the average monthly return in Australia.The peaks in January and July are quite clear.Also note the large positive return in December.
In Australia,which day of the week has equity returns that are on average 'low?

Question 8

Returns in the Australian market are on average positive in which of the following months?

Question 9

Efficiency predicts that when markets reach a peak there will often be a 'realignment' or 'market correction'.

Question 10

It is impossible for markets to incorporate all information into prices.

Question 11

The study by Brailsford and Faff (1993)shows that the All-Ordinaries Index exhibits autocorrelation in the order of:

Question 12

Figure 10.6,page 334,shows Beedles,Dodd and Officer's (1988)study.The authors find that Australian small firms have risk-adjusted returns of around 8% p.a.
Which of the following beliefs would not preclude charting as a method of portfolio management?

A)The market is strong form efficient.
B)The market is semi-strong form efficient.
C)The market is weak form efficient.
D)Stock prices follow recurring patterns.

Question 13

The Australian study by Easton in 1990 found an insignificant jump in stock returns around extraordinary item announcements.

Question 14

Random price movements indicate ________.

A)irrational markets
B)that prices cannot equal fundamental values
C)that technical analysis to uncover trends can be quite useful
D)that markets are functioning efficiently

Question 15

Beedles,Dodd and Officer (1988)find that Australian small firms have risk-adjusted returns of around 8% p.a.

Question 16

Haugen and Lakonishok (1988)seek to replicate the trading strategy in the USA by:

Question 17

Positive autocorrelation implies that negative price changes are followed by positive price changes.

Question 18

The presence of autocorrelation in stock returns is consistent with market efficiency.

Question 19

The weak form efficiency states that all past information,including security price and volume data,must be reflected in the current stock price.

Question 20

The large positive returns observed for firms in the Australian market in July and January are primarily caused by market overreaction.

Question 21

An abnormal return is calculated as:

Question 22

Lakonishok,Shleifer and Vishny (1994)provide arguments why fund managers will avoid:

Question 23

Loyalists believe that the long-term patterns in returns are induced by institutional and/or research method problems such that the patterns are artificial and therefore not exploitable.Examples are:

Question 24

An unbiased reaction is one where there is ___ to the arrival of new information.

Question 25

Trading on the NYSE is halted for one hour if the Dow Jones Index falls by:

Question 26

Event study tests generally focus on the price reaction to

Question 27

The hypothesis that argues that there is a downward price pressure at the end of the tax year on shares that have experienced recent price declines as investors attempt to sell in order to realise capital losses is the:

Question 28

The production of _____ is more likely to be greater during trading periods.

Question 29

Growth shares are those firms that are expected to grow at a faster rate than:

Question 30

The presence of negative correlation over long horizons is consistent with:

Question 31

Which of the following strategies will be profitable if the market overreacts?

Question 32

Loyalists believe that the long-term patterns in returns are induced by:

Question 33

According to the semi-strong form efficient: ____________.

A)stock prices do not rapidly adjust to new information
B)future changes in stock prices cannot be predicted from any information that is publicly available
C)corporate insiders should have no better investment performance than other investors even if allowed to trade freely
D)arbitrage between futures and cash markets should not produce extraordinary profits

Question 34

Banz (1981)has evidenced a trading strategy in the USA that can earn risk-adjusted profits of around 20% by taking:

Question 35

Transaction costs of taking a short position exceed those of a long position by:

Question 36

The more profitable IPO investments seem to be those:

Question 37

Prospect theory provides an explanation for why individuals tend to

Question 38

Bowman and Buchanan (1995)argue that there are two sets of forces at work that operate as impediments to the acceptance of efficient markets.These are:

Question 39

By using the Consumer Price Index (CPI)as an economic indicator,it can be argued that it has a:

Question 40

Short-term profits are expected to be greatest by forming a position on/in _________ and closing it in ____________.