1、PowerPoint to accompanyChapter 10The pricing efficiency of capital marketsFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaOverview In this lecture we will:Outline the theory of market efficiency Define the term market efficiency Explain how markets are kept efficient Discu
2、ss different possible levels of market efficiency Examine tests of the efficiency of the ASX Review relevant research published in academic journalsFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaMarket efficiency theory Market efficiency specifically relates to informatio
3、nal efficiency,and is concerned with how rapidly security prices reflect or impound new information that arrives to the marketFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaMarket efficiency theory(cont)Professor Eugene Fama(University of Chicago)defines market efficiency
4、 as an hypothesis:“THE SIMPLE STATEMENT THAT SECURITY PRICES FULLY REFLECT ALL AVAILABLE INFORMATION”The Oxford English Dictionary defines hypothesis as:“A PROVISIONAL SUPPOSITION FROM WHICH TO DRAW CONCLUSIONS WHICH SERVES AS A STARTING POINT FOR FURTHER INVESTIGATION BY WHICH IT MAY BE PROVED OR D
5、ISPROVED”But how are security prices kept efficient?Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaWhat keeps security prices efficient?Case Study At around 1.05pm on 30 August 2005,Tabcorp Holdings released a preliminary final report This information was used by investor
6、s to revise(upward)the cash flows forecast for Tabcorp,resulting in a permanent upward revision of the fair value of Tabcorp The price of Tabcorp shares rose from:$16.29 at 1.00pm to$16.64 at 1.30pmFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaThe price of Tabcorp agains
7、t the ASX200 on 30/8/0513.5010.4015.0014.1013.004445.04440.04435.04430.04425.04420.04415.04410.04405.04000.04395.04390.0Index valueTAHASX20015.9016.0016.1016.2016.3016.4016.5016.6016.7016.80Price($)10.0010.1010.2010.3010.5011.0011.1011.2011.3011.4011.5012.0012.1012.2012.3012.4012.5013.1013.2013.3013
8、.4014.0014.2014.3014.4014.5015.1015.2015.3015.4015.5016.0016.10Time(CONT)What keeps security prices efficient?FIGURE 10.1Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia If all market players had accurately predicted the content of the earnings release prior to 1.05pm:Ther
9、e would have been large buying pressure in Tabcorp Holdings This would have pushed the price up before the release When the earnings report was made public the share price would not have changed Any attempt to trade on the information would have netted no profit,because the share price would already
10、 have reflected,or impounded,the content of the information release(CONT)What keeps security prices efficient?Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia Security analysts Analyse information related to stocks that they follow,and forecast the future cash flows and sh
11、are value of these stocks Trading based on this analysis has two important consequences:The first clients to trade make a profit The trading process causes security prices to reflect the information uncovered by analystsHence,it is the activities of security analysts and their clients that cause pri
12、ces to be efficient(CONT)What keeps security prices efficient?Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaLevels of market efficiency Fama(1970)identified three levels of market efficiency:Weak-form efficiencySemi-strong-form efficiencyStrong-form efficiencyPrices refl
13、ect all information contained in the record of past pricesPrices fully reflect all publicly available informationAll available information is fully reflected in current pricesFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaLevels of market efficiency(cont)Development of we
14、ak-form efficiency1.Traders might have access to new information,and begin to reveal that information by the effect on prices2.Perceiving a trend,other market participants may transact in an attempt to profit from the new information3.This speeds up the impounding of the information revealed by the
15、initial price movement subsequent movements after the initial information has been impounded will be randomFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaLevels of market efficiency(cont)Implications of semi-strong-form efficiency1.Must also be weak-form efficient,because
16、 historic prices are publicly available information2.Reacts immediately to the release of any new information contained in information announcements Implications of strong-form efficiency1.Must also be semi-strong-form efficient(and therefore weak-form efficient)because publicly available informatio
17、n forms part of“all available information”2.Prices should reflect private information,or information known only to a group of participantsFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaPrivate information Inside information is information known only to those who are in a
18、privileged position in relation to a company Such information could,in theory,be reflected in prices if insiders trade on information and are able to move prices,thus revealing the information Insider trading is illegal in Australia and in most developed countries,but that doesnt necessarily mean it
19、 doesnt occurFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaTests of the efficiency of the Australian Stock Exchange Several tests can help determine whether a market is efficient We will look at the following tests of capital market efficiency:Do prices follow a“random w
20、alk”?Are trading rules profitable?Do prices react rapidly to information from earnings announcements or large trades?Is it possible to profit from insider trading?Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaIs the ASX weak-form efficient?If a market is weak-form effici
21、ent,price movements should be random and should not exhibit trendsTwo possible implications of this prediction:1.Prices should follow a“random walk”Where the current price(Pt)is unrelated to the previous price(Pt-1),or if the value linking the two(e.g.)is a random number,as follows:2.Trading rules b
22、ased on detecting and trading on price patterns should be unprofitablePt Pt1(10.1)Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia FIGURE 10.2 shows the level of the ASX200 index from Jul 2002 to Sep 2005 Some periods show broad trends in prices e.g.the general increase be
23、tween Sep 2004 and Mar 2005Is the ASX weak-form efficient?(cont)Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia Over shorter time frames-upward movements seem to follow previous upward movements(e.g.area A)downward movements seem to follow previous downward movements(e.g.
24、area B)Is the ASX weak-form efficient?(cont)FIGURE 10.2Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia Given these perceived patterns there should be a very strong positive relationship between price movements on consecutive days However,when price level movements are com
25、pared across consecutive days,this is not the case.ASX is weak-form efficientIs the ASX weak-form efficient?(cont)FIGURE 10.2Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaAre mechanical trading rules profitable on the ASX?In a weak-form efficiency it should not be possib
26、le to make systematic profits from trading rules set up to detect and trade on the basis of price trends An example of such a trading rule is a filter rule,where the filter represents a percentage applied to share movements Example:A 10%filter rule Buy if the stock rises 10%from its previous lowest
27、price Sell if the stock falls 10%from its previous highest price Assumption:The trend identified by the rule will continueFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaAre mechanical trading rules profitable on the ASX?(cont)Application of a 10%filter rule to BHP shares
28、between January 1969 and July 1970FIGURE 10.3Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia Ball(1978)found that the differences between returns on the filter securities and the paired securities is quite small Ball concluded that it is not possible to make profits from
29、trading rules relying on price patterns,implying that the ASX is weak-form efficient More recent studies in other markets have unanimously reported that no useful information can be obtained from past pricesAre mechanical trading rules profitable on the ASX?(cont)Frino,Hill,Chen:Introduction to Corp
30、orate Finance,4e 2009 Pearson AustraliaIs the ASX semi-strong-form efficient?In a semi-strong-form efficient market,prices impound all publicly available information,and therefore should adjust immediately after information announcements The most common test of semi-strong-form efficiency is an even
31、t study,which examines the behaviour of prices around information events The purpose of the study is to analyse how quickly new information is reflected in share pricesFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia Since stock-price movements may be caused by broad marke
32、t movements as well as information conveyed by an event,it is necessary to isolate abnormal returns(ARt),as follows:where:Rt=the actual returnE(Rt)=the expected return in the interval t It is normal to use the CAPM to estimate expected returnsARt Rt E Rt(10.2)Is the ASX semi-strong-form efficient?(C
33、ONT)Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaExample 10.1 On 22 August 2005,Toll Holdings announced that it was attempting to take over Patrick Corporation.The daily stock prices and ASX200 values around the time of the announcement as are as follows.DatePatrick Cor
34、p price($)ASX200 Accum.Index16 August5.812580017 August5.932572318 August5.702558019 August6.452568822 August7.382591323 August7.252584124 August7.2025623Is the ASX semi-strong-form efficient?(CONT)Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaExample 10.1(cont)On 22 Aug
35、ust 2005,Toll Holdings announced that it was attempting to take over Patrick Corporation.If the beta of Patrick Corporation is 0.91 and 90-day BABs were yielding 5.65%p.a.,calculate the abnormal return of Patrick Corporation on the days before and after the announcement._ Patrick Corp daily returnAc
36、cum.Index daily returnExpected returnAbnormal returnCalculation11tttPPP11tttIIIfmfRRRttRER(CONT)Is the ASX semi-strong-form efficient?Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaExample 10.1(cont)The abnormal return on the day of the announcement 13.62%,and on the day
37、following the announcement-1.51%Patrick Corp daily return(%)Accum.Index daily return(%)Expected return(%)Abnormal return(%)CalculationPt Pt1Pt1It It1It1RfRm RfRt E Rt 17 August2.07-0.30-0.272.3418 August-3.88-0.56-0.50-3.3719 August13.160.420.3912.7722 August14.420.880.8013.6223 August-1.76-0.28-0.2
38、5-1.5124 August-0.69-0.84-0.770.08Is the ASX semi-strong-form efficient?(CONT)Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaDo stock prices on the ASX react rapidly to information?Aitken,Brown,Frino and Walter(1995),studied 30-minute abnormal stock price returns around e
39、arnings announcements The study analysed announcements by 156 companies on the ASX during the year ended 30 June 1992 The sample was divided into:Large stocks and small stocks Good news and bad news announcements Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaDo stock pri
40、ces on the ASX react rapidly to information?(cont)Large stocks announcing good newsLarge stocks announcing bad newsFIGURE 10.4Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaDo stock prices on the ASX react rapidly to information?(cont)Small stocks announcing good newsSmal
41、l stocks announcing bad newsFIGURE 10.5Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaDo stock prices on the ASX react rapidly to large trades?Another test of semi-strong-form efficiency is to analyse how quickly prices adjust to information conveyed by large trades,or bl
42、ock trades Assumption:Large traders,such as fund managers,are better informed than small traders Hence,a large buy order might indicate to the market generally that a stock is underpriced,and a large sell order might indicate over-pricingFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pear
43、son AustraliaDo stock prices on the ASX react rapidly to large trades?(cont)Aitken and Frino(1996)studied 4,554 block buy orders and 4,554 block sell orders between 1 July 1991 and 30 June 1993 The average size of block:buy orders=$339,637 sell orders=$355,423 There are large upward and downward mov
44、ements following block buy and sell orders,respectively FIGURE 10.6Frino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaIs the ASX semi-strong-form efficient?There is some evidence to suggest that the ASX is semi-strong-form efficient:In most cases,the information contained in
45、earnings announcements is reflected in share prices within 30 minutes One possible exception is good news from small companies it takes more time for this information to be reflected in prices It takes no more than three trades for the information conveyed by large trades to be impounded Frino,Hill,
46、Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaIs the ASX strong-form efficient?Historically,in Australia there have been convictions for illegal,profitable insider trading If a market is strong-form efficient,it should not be possible to profit from insider trading Fund managers,al
47、so,arguably have access to more timely,accurate information than the general public Nevertheless,fund managers do not make abnormal returns(Sawicki,2000)Therefore the ASX is likely to be semi-strong-form efficientFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson AustraliaEvidence aga
48、inst the Efficient Markets Hypothesis A final word Although most studies have concluded that the ASX is at least semi-strong form efficient,a substantial body of academic literature suggests otherwise These studies are based on repeated patterns,or seasonal behaviour,in stock price movements These e
49、xistence of these anomalies is contrary to the weak-form version of the Efficient Markets HypothesisFrino,Hill,Chen:Introduction to Corporate Finance,4e 2009 Pearson Australia Anomalies uncovered in the Australian market include:Prices tend to rise at the end of the day(the day-end effect)Prices ten
50、d to fall on Tuesdays(the day-of-the-week effect)Prices tend to rise in January(the January effect)Returns on small stocks tend to be larger than on large stocks(the size effect)Evidence against the Efficient Markets Hypothesis A final word(cont)Frino,Hill,Chen:Introduction to Corporate Finance,4e 2
