HRM (2012-14) Batch, XLRI

What will you do when

Basic Financial Management Efficient Market Hypothesis

You value a stock at Rs.200 It is available in the market at Rs.50

Head: I give You Rs.200 Will you play this game?

Give Me Rs.50 Tail: I give You Rs.200

What EMH Says

Implications of EMH

Investors are rational. Any money making opportunity will immediately be grabbed.

H ?S How? Suppose you fi find daR Rs.500 500 note t l lying i next t to the hostel. For how long will it remain there?

There is no Free Lunch If you made a lot of money, that is not necessarily due to your ability.

Therefore the stock price at any time will always incorporate all information in it. Price = Intrinsic Value. There is no free lunch.

The dividing line between ability and luck is very thin. Dont expect such high returns to come in future.

Invest in a diversified portfolio and expect a decent return from this portfolio.

You may get more (or less). But that could not have been predicted.

Suppose the market were not efficient

Who will not believe in Market Efficiency?

Brokerage Houses: Mutual Funds

Prof. Mohanty

HRM (2012-14) Batch, XLRI

Why Some People Do Not Believe in EMH?

Different Investment Philosophies

One Question: Three Answers A stock is trading at Rs.200. You think its true value is Rs.50. What will you do?

Empirical Evidence Behavior of Investors Bubbles in the market

When the internet bubble busted, over $8 trillion of market value evaporated. It is as if a years output of the economies of Germany, France, England, Italy, Spain, Holland, and Russia completely evaporated.

Castle in the Air Philosophy Firm Foundation Approach Efficient Market Hypothesis

Castle in the Air Theory

EMH and Technical Analysis

Also called Greater Fool Theory A thing is worth only what someone else will pay for it it.

Weak-form Efficiency

Can you predict the future stock prices by using past stock prices data?

Latin Proverb

Yes: Market Y M k ti is weak-form kf i inefficient ffi i t No: Market is weak-form efficient.

Technical Analysis

Market is inefficient: There are patterns in past stock prices. They tend to repeat. Market is efficient: There is no pattern. It is an optical illusion.

AxisBank(Correlation= 0.001)

Titan(Correlation=0.004)

EMH Versus Technical Analysis

25% 20% 15% 10% 5% 20% 0% 10% 5% 0% 10% 15% 20% 10% 20% 30% 20%

30% 20% 10% 0% 10% 0% 10% 20%

10%

20%

30%

Technical analysis. Stock prices do follow trends or patterns. There are investors who have made money using technical analysis.

Wipro(Correlation=0.048)

ITC(Correlation=0.032)
15%

25% 20% 15% 10% 5% 30% 20% 0% 10% 5% 0% 10% 15% 20% 25% 15% 10% 15% 10% 20% 30% 10% 5% 5% 10% 5% 0% 0% 5% 10% 15%

EMH. No such pattern exists. This pattern or trend is an optical illusion. The market has no memory. There are investors who have lost money using technical analysis.

Prof. Mohanty

HRM (2012-14) Batch, XLRI

Technical Analysis Report

The markets rise after a period of reaccumulation is a bullish sign. Nevertheless, fulcrum characteristics are not yet clearly present and a resistance area exists 40 points higher in the Dow, So it is clearly premature t say the to th next t leg l of f the th bull b ll market k t is i up. If If, in i th the coming weeks, a test of the lows holds and the market breaks out of its flags, a further rise would be indicated. Should the lows be violated, a continuation of the intermediate term downtrend is called for. In view of the current situation, it is a distinct possibility that traders will sit in the wings awaiting a clearer delineation of the trend and the market will move in a narrow trading range.

Some other theories to make you lose money

Contrarian Theory

You BUY (SELL) when somebody else SELLS (BUYS).

Orange Juice Theory

Why Some People Use Technical Analysis

Firm Foundation Theory

Fundamental analysis

Brokers use it to earn brokerage fees fees.

Economic analysis Industry analysis Firm analysis

Believes that people behave irrationally

Semistrong-form Efficiency

Can you predict the future stock prices by using publicly available data?

Yes: Market is semistrong-form inefficient No: Market is semistrong-form efficient.

How SGX attempts to make the market efficient

Fundamental Analysis Versus EMH

Fundamental analysis Excess return can be earned by using fundamental analysis Examples of Warren Buffet and Peter Lynch

SGX-MAS research initiative Covers 187 companies Covered by 12 research firms Free membership Should cover less-researched topics

EMH Excess return cannot be earned by using fundamental analysis consistently Borrel Cantelli Lemma

Prof. Mohanty

HRM (2012-14) Batch, XLRI

Empirical Evidence on Semistrong Efficiency

Market is semi-strong efficient

Performance of the mutual funds Day of the week effect Month effect (not found in India) Value vs. Glamour stocks Size effect And many more

Market is semi-strong inefficient

Day of the Week Effect: Indian Evidence

Month Effect: India

Strong Form Efficiency

Moral of the Story

Market discounts all the information available about the stock. This includes information available to the public as well as the insider information information. Strong-form Efficiency

EMH is based on valid arguments Unless you have very strong evidence to the contrary contrary, always assume that the market is efficient

Can you predict the future stock prices by using all types of data?

Examples of finance companies

Yes: Market is strong-form inefficient No: Market is strong-form efficient.

A joke to summarize EMH

Empirical evidence shows that market is strong form inefficient.

Prof. Mohanty