Efficient Market Hypothesis and Stock Market Analysis

1. Efficient Market Hypothesis implies: prices reflect all available information.

2. In an efficient market, professional portfolio management can't offer superior risk-return trade-off.

3. Strong-form focuses on the most inclusive set of information.

4. Contradict stock market is weakly efficient? Every January, abnormal returns.

5. One could have made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

6. Evidence against semistrong form? Low P/E stocks tend to have positive abnormal returns.

7. Prices of stocks before large dividend increases show consistently positive abnormal returns. No violation of EMH.

8. Consistent (C) or violation (V) of Efficient Market Hypothesis (EMH)

- Half professionally managed mutual funds can outperform S&P 500 - C

- Managers outperforming one year likely out next year - V

- Stock prices more volatile in January - C

- Stock prices outperforming in January likely out in February - V

- Stocks performing well one week perform poorly the next - V

9. Confidence index = Aa-rated bond yield/Baa bond yield

10. Behavioural Characteristics:

- Conservatism bias (investors are slow to update beliefs given new evidence)

- Regret avoidance/fear of regret

- Mental accounting (less risk tolerance for retirement accounts)

- Disposition effect (reluctant to sell stocks with 'paper' losses)

- Representativeness bias (investors disregard sample size)

13. Bullish Signal: stock price crosses above 52-week moving average.

14. Trin Ratio = (volume declining/number declining)/(value advancing/number advancing)

- Trin ratio < 1 bullish signal

15. Breadth = number advancing - number declines

- Breadth > 0 bullish signal

16. Intrinsic Value (Vo) (formula)

- D = dividend*(1+g)

- Dh + Ph = last D * (1+ g after t)

- k = required return (DDM)

17. Intrinsic value (formula). (pass to % after)

19. Market-to-Book Ratio = Market value firm/Book value firm

- Market value firm = A - Liabilities (market value)

- Book value firm = A - Liabilities (book value)

20. Growth Rate and P/E Ratio

- g = ROE*b. (pass to % after)

- b is plowback ratio

- P/E = (1-b) / (k-g) (not in %)

- k = market capitalization rate of firm

21. Market Capitalization Rate

- k = rf + beta (E(market) - rf)

- Intrinsic Value of the Stock (don't take into account constant growth rate in numerator, but put it in denominator, if not given current growth)

22. Constant-growth DDM (formula)

- k = expected rate of return

- if price falls, P/E ratio decreases

23. Po and P3 (formulas)

24. Po and E(r) (formulas)