THE EFFICIENT MARKETS HYPOTHESIS AND CAPITAL ASSET PRICING MODEL

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1 THE EFFICIENT MARKETS HYPOTHESIS AND CAPITAL ASSET PRICING MODEL
WZ CH 2 SCOTT CH 4

2 THE EFFICIENT MARKETS HYPOTHESIS
Jensen (1978) defines an efficient market as follows: A market is efficient with respect to information set θt if impossible to make economics profits by trading on the basis of information set θt Artinya: pasar dapat dikatak efficient apabila informasi tercermin dalam harga saham secara cepat dan penuh Things to consider: Risk-adjusted rate of return On average Economic profit are net of all costs

3 THE EFFICIENT MARKETS HYPOTHESIS (CONT’D)
3 broad categories: Weak form Semistrong form Strong form Harga saham mencerminkan data perdagangan (harga dan volume perdagangan) masa lalu Analisis teknikal tidak dapat digunakan untuk memperoleh abnormal return Semi strong form Harga saham mencerminkan data perdagangan masa lalu dan informasi publik Analisis fundamental tidak lagi dapat digunakan dalam memperoleh abnormal return Harga saham mencerminkan data perdagangan masa lalu, informasi publik, dan informasi non publik Pada prakteknya tidak ada pasar jenis ini, karena kalau ada market menjadi tidak menarik

4 THE EFFICIENT MARKETS HYPOTHESIS AND THE PREVIOUS LITERATURE
A common hypothesis in the early 1960s: corporate accounting reports are the only source of information on the corporation Led to the criticisms of the calculation of accounting earnings Competing hypothesis: mechanistic hypothesis/ monopolistic hypothesis)

5 THE EFFICIENT MARKETS HYPOTHESIS AND THE PREVIOUS LITERATURE (CONT’D)
Underlying the EMH: competition for information The market is not systematically misled by accounting earnings

6 THE CAPITAL ASSET PRICING MODEL
Original CAPM model assumption: The only parameter: E(ri) and σ2(ri) Markets are perfect Investor are rational and risk averse Investor assume that other individuals also act rationally Costless access to information and homogeneous expectation Riskless asset and all individuals can borrow and lend at riskless rate

7 CAPM AND ACCOUNTING NUMBERS
The potential for information in accounting numbers Accounting earnings can be associated with cash flow Accounting number can supply information on other variable in CAPM: Expected rate of return Expected rate of return depends on the risk of the asset

8 CAPM AND ACCOUNTING NUMBERS (CONT’D)
The specified relation between earnings and stock prices Concentrate on the relation between changes in earnings and changes in stock prices around earnings announcement Relation between unexpected earnings and the abnormal rate of return: Ball and brown (1968)

9 CAPM AND ACCOUNTING NUMBERS (CONT’D)
The specified relation between earnings and stock prices (cont’d) Unexpected accounting earnings that are solely the result of accounting procedures will not be associate with the abnormal rate of return, unless they are also related to unexpected changes in risk or cash flow

10 CAPM AND ACCOUNTING NUMBERS (CONT’D)
The market model Empirical test of the relation between abnormal rate of return and unexpected earnings require estimate of normal rates of return and unexpected earnings Normal rates of return are typically determined by using the market model: Rit= αi + βirmt + it it is abnormal rate of return