Term
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Definition
| The theory that stock price movements are unpredictable, so there is no way to know where prices are headed |
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Term
| What are random walks a result of? |
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Definition
| This random pattern is a natural outcome of markets that are highly efficient and respond quickly to changes in material information |
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Term
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Definition
| A market in which securities reflect all possible information quickly and accurately |
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Term
| What 4 things must you have for an efficient market? |
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Definition
1. Many knowledgeable investors actively analyzing and trading stocks
2. Information is widely available to all investors
3. Events, such as labor strikes or accidents, tend to happen randomly
4. Investors react quickly and accurately to new information |
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Term
| Efficient Market Hypothesis |
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Definition
| Information is reflected in prices—not only the type and source of information, but also the quality and speed with which it is reflected in prices. The more information that is incorporated into prices, the more efficient the market becomes |
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Term
| 2 implications the EMH has for investors and firms |
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Definition
1. Since information is reflected in security prices quickly, knowing information when it is released does an investor little good.
2. Firms should expect to receive the fair value for securities that they sell. Firms cannot profit from fooling investors in an efficient market. |
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Term
| What does the weak form of EMH assume? |
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Definition
| Current stock prices fully reflect all currently available security market information |
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Term
| What 2 conclusions does the weak form of EMH make? |
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Definition
1. It contends that past price and volume data have no relationship with the future direction of security prices, ie everything is random
2. It concludes that excess returns cannot be achieved using technical analysis. |
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Term
| What strategy does the weak form of EMH advocate for? |
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Definition
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Term
| What tends to eliminate any profit opportunity associated with stock price patterns? |
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Definition
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Term
| What does the semi-strong form of EMH assume? |
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Definition
| Current stock prices adjust rapidly to the release of all new public information. |
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Term
| What 2 conclusions does the semi-strong form of EMH make? |
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Definition
1. It contends that security prices have factored in available public information.
2. It concludes that excess returns cannot be achieved using fundamental analysis. |
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Term
| What does the strong form of EMH assume? |
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Definition
| Current stock prices fully reflect all public and private information. |
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Term
| What 2 conclusions does the strong form of EMH make? |
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Definition
1. It contends that market, non-market and inside information is all factored into security prices and that no one has monopolistic access to relevant information.
2. It assumes a perfect market and concludes that excess returns are impossible to achieve consistently. |
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Term
| 4 types of market anomalies |
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Definition
| 1. Calendar effect 2. Small firm effect 3. Post-Earnings announcement drift (momentum) 4. Value effect |
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Term
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Definition
- Stocks returns may be closely tied to the time of year or time of week
- Questionable if really provide opportunity
- Examples: January effect, weekend effect |
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Term
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Definition
- Size of a firm impacts stock returns
- Small firms may offer higher returns than larger firms, even after adjusting for risk |
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Term
| Post-Earnings Announcement Drift |
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Definition
- Stock price adjustments may continue after earnings adjustments have been announced
- Unusually good quarterly earnings reports may signal buying opportunity |
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Term
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Definition
- Uses P/E ratio to value stocks
- Low P/E stocks may outperform high P/E stocks, even after adjusting for risk |
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Term
| Possible Explanations to market anomalies |
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Definition
1. Stocks that appear to earn abnormally returns are actually riskier, so higher returns merely represent compensation for risk
2. Some anomalies may simply be patterns in that data that appeared by chance and are thus not likely to persist over time
3. Behavioral biases may cause investors to make systematic mistakes when they invest, and those mistakes create inefficiencies in the market |
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Term
| What does investor overconfidence usually result in? |
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Definition
| Investors underestimating risks |
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Term
| How is the self-attribution bias used in financial markets? |
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Definition
- Investors tend to take credit for successes and blame others for failures
- Investors will follow information that supports their beliefs and disregard conflicting information |
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Term
| Loss Aversion and its effects |
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Definition
- Investors dislike losses much more than gains
- Investors will hang on to losing stocks hoping they will bounce back |
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Term
| Representativeness and its effects |
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Definition
- Investors tend to draw strong conclusions from small samples
- Investors tend to underestimate the effects of random chance |
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Term
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Definition
| Investors tend to analyze a situation in isolation, while ignoring the larger context |
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Term
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Definition
| Investors tend to ignore information that conflicts with their existing beliefs |
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Term
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Definition
| Investors buy stocks that are familiar to them without regard to whether the stocks are good buys or not |
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Term
| How long does the momentum of stock price ups and downs continue? |
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Definition
| 6- to 12-month time horizons |
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Term
| What happens to investors who believe they have superior information? |
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Definition
| They tend to trade more, but earn lower returns |
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Term
| What effect do investors who act on emotion rather than facts have on the market? |
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Definition
| They reduce market efficiency |
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Term
| What types of stocks do investors tend to sell? |
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Definition
| Stocks that have risen in value rather than declined |
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Term
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Definition
| A bias that analysts tend to issue similar recommendations for stocks - Analysts may be overly optimistic about a favorite stock's future |
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Term
| 5 ways to use behavioral finance to improve investment results |
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Definition
1. Don't hesitate to sell a losing stock
2. Don't chase performance
3. Be humble and open-minded
4. Review the performance of your investment on a periodic basis
5. Don't trade too much |
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