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  Chapter 12: Market EfficiencyCHAPTER OVERVIEW  A chapter on market efficiency is a natural sequence to the other two chapters in Part IV dealing with common stocks. It is also desirable for students to be familiar with this topic at this point so that market efficiency can be referred to when discussing other topics, such as technical analysis or fundamental security analysis. Chapter 1 begins by e!plaining the rationale for arguing that the market is efficient. It then proceeds to outline the classic three forms of market efficiency laid out by ama in 1#$%& weak, semi'strong, and strong. ()idence on market efficiency is presented in some detail, starting with weak form efficiency and concluding with strong form efficiency. *ithin the weak form section the distinction is made between statistical tests and trading rule tests. In the semi'strong form section the concept of e)ent studies is de)eloped, along with abnormal returns. +trong form e)idence is de)eloped in considerable detail.Chapter 1 presents a thorough analysis of the implications of the (-. his is important in getting students to think about the real issues in)ol)ed here. he implications for both technical analysis and fundamental analysis are considered, along with those for money managers. his discussion ser)es as a good introduction to the last part of the chapter on possible market anomalies.Chapter 1 concludes with a complete discussion of possible market anomalies or e)idence of possible market inefficiency. his e)idence is di)ided into earnings announcements /which is related to the une!pected earnings concept in Chapter 10, low P2( ratios, the si3e effect, the 4anuary effect, and the Value 5ine results. he chapter ends with some conclusions about market efficiency. It is important for students to think about what they ha)e learned and the implications for their approach to in)esting in general and to such areas as technical analysis in particular. he reference to the 6eane article / Financial 169  Analysts Journal , arch'April 1#78 is important. his is a )ery desirable article to read with regard to efficient markets.9)erall, most instructors will want to lea)e their students with a balanced )iew of the efficient market contro)ersy. Certainly, the e)idence on market efficiency cannot be ignored. It is too well documented, and augmented by such factors as the mediocre performance of professional fund managers. 9n the other hand, to date no one has conclusi)ely e!plained why the anomalies e!ist. here may in fact be e!planations, but they ha)e not been widely accepted. uch work in this area remains to be done. +tudents must reali3e that in the area of efficient markets, as in numerous other areas of in)esting, there is no definiti)e answer, which is uni)ersally agreed upon and no definiti)e, uni)ersal statement that can be made. CHAPTER OBJECTIVES  o e!plain the rationale for efficient markets and what the concept means.  o present the three forms of market efficiency and well known empirical e)idence concerning each of the three forms.  o consider the possible market inefficiencies /anomalies that ha)e been widely discussed to date. 170   MAJOR CHAPTER HEAI! S #C$ntent%&The C$ncept $f an Efficient Market  *hat is an (fficient arket:;prices fully reflect information quickly and accurately< diagram and e!planation of ad=ustments to information>  *hy the ?. +. arket Can @e (!pected to @e (fficient;many participants, widely a)ailable information randomly generated, in)estors react quickly to the new information>  he International Perspecti)e;would seem reasonable that most foreign markets are less efficient, but new e)idence suggests strong contemporaneous relationships among regional e!changes that are open at the same time>  orms of arket (fficiency;weak, semistrong, strong> E'i(ence On Market Efficiency  *eak' orm ()idence;statistical tests of price changes, trading rule tests, weak'form contra'e)idence>  +emistrong' orm ()idence;e!planation of e)ent study, abnormal return, and cumulati)e abnormal return< re)iew of e)idence in)ol)ing stock splits, money supply changes, accounting changes, di)idend announcements, reactions to other announcements>  +trong'form ()idence;corporate insiders> 171  I)p*icati$n% $f the Efficient Market Hyp$the%i%  or echnical Analysis  or undamental Analysis  or oney anagement E'i(ence $f Market An$)a*ie%  (arnings Announcements;une!pected earnings, +?( analysis>  5ow P2( atios;@asu studies, Breman arguments>  he +i3e (ffect;small firms outperform large firms on risk'ad=usted basis>  he 4anuary (ffect;the strong performance in 4anuary by small'company stocks>  he Value 5ine anking +ystem;the performance of the 0 ranking categories>  9ther Anomalies;brief mention of others, such as the neglected firm effect> S$)e C$nc*+%i$n% A,$+t Market Efficiency ;6eanes arguments< the 9ctober 1#7$ market crash> POI!TS TO !OTE ABO-T CHAPTER 12Ta,*e% an( .i/+re% igures 1'1 and 1' are to help students )isuali3e the ad=ustment process of stock prices to information and the cumulati)e le)els of efficiency, respecti)ely. 172
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