2.3.BKM Ch 11

Historical data suggests stocks' return are subject to a random walk process: it reflects new info that arrives in an unpredictable way

• 1. Weak form: prices reflect historical info
• 2. Semi strong: prices reflect public info
• 3. Strong: all info is reflected, including insider

• Technical analysis: analyse trends. Usually self-destructive
• Fundamental analysis: use valuation methods to constantly value stock based on expected cash flow
• None of those techniques is likely to be of much value, but at the same time they help spotting anomalies and correcting them.
• For many investors, the best strategy is the passive one

Use impact of info on stock price to assess value of an event (eg: acquisition)

• Magnitude issue: differentiating random noise and tiny degree of inefficiency is likely impossible
• Selection bias: those who know how to beat the mkt don't share their method
• Lucky event issue: even in the case where a theory worked in the past, it could simply be due to randomness

• Momentum: PF tend to continue their best/worst performance from recent past
• P/E effect: low P/E stocks outperform high ones, even after adjusting for diff in β
• January small firm: small firms usually outperform large ones, especially in January
• Neglected firms effect: tend to show higher return
• Book to market ratio: seem to influence stock price as well

Prices seem to reflect expected results and react accordingly to announcements, however, the abnormal returns tend to drift further up/downwards after the announcement date. This suggests that people don’t fully reflect the surprises quickly enough in the price.

• 1. Necessary for rational diversification
• 2. Require tax consideration
• 3. Security selection is required to address diff investors' risk profile
• 4. Necessary to match investment objective with investors' age