Question

Note whether the following phenomena would be consistent with or a violation of the efficient market hypothesis. a. Nearly half of all professionally managed mutual funds are able to outperform the S&P 500 in a typical year. Consistent Violation b. Money managers that outperform the market (on a risk-adjusted basis) in one year are likely to outperform in the following year. Consistent Violation c. Stock prices tend to be predictably more volatile in January than in other months. Consistent Violation d. Stock prices of companies that announce increased earnings in January tend to outperform the market in February Consistent Violation e. Stocks that perform well in one week perform poorly in the following week. < Prey 3 of 6 !!! Next >

Answer 1

Ans ).The efficient market hypothesis in short EMH is based on the assumption that the market comprises rational investors. The term rational means that investors will select assets based on their risk -return profile.Hence on the basis of level of information the EMH can be divided into three forms namely, weak form,Semi-strong form and Strong form.Weak form says that current prices fully reflect all historical informations hence future price changes are independent of past prices hence any attempt made to predict future price based on past trends is totally futile.Semi - strong form says that the prices adjust to such information quickely and accurately so abnormal profits on a consistent basis cannot be earned.According to the strong form prices of securities fully refect all available informations -both private and public. Hence the investors know all the information both public as well as private. Hence a particular investor cannot reap abnormal profits using this information.

a. Violation as mentioned above the half mutuals funds cannot out performed the index since it results in rice in price which according to EMH efficient market hypothesis cannot be true as the investors cannot be able to make abnormal profits using the public information through fund managers.

b.Violatio. As according to EMH absolute price changes are independent in the short run as assuming market comprising of rational investors and managers but they consider factors other than risk and return and behaviour of the participents which is driven by their sentiments rather then historical prices and returns.

c.Consistent. It is known as January Anomaly as most of the investors adopt tax selling at the end of year to establishes losses on stocks that have declined and reacquire the same shares in the next year or buy other stocks that are attractive the EMH believes that tis kind of changes is seasonal and does not last for long.

d.Consistent .The dividend change has an information effect because it indicates that management expects a new higher earnings in future which interns influences the sentiments of the investors.

e.Consistent . Weekend effect is the above effect mentioned .The Efficient market hypothesis does not rules out anomalies such as January effect and weekend effect like in this question hence prices will be over or undervalued only in random manner and will ultemately revert back to mean positions.