Financial Economics 15pts For Questions I To IV Choose Only

Financial Economics1 15pts For Question I to Iv Chooseonlyone Answ

Financial Economics 1. (15pts) For Question I to IV, choose only one answer and explain the rationale in one or two sentences.

I. (3pts) Which of the following contradicts the proposition that the stock market is weakly efficient? a) An analyst is able to identify mispriced stocks by looking at stock charts. b) Mutual funds do not outperform the market on average. c) Some investors can earn abnormal profits. d) The autocorrelations of stock returns are not significantly different from zero.

II. (3pts) Which of the following would provide the strongest evidence against the semi-strong form of the efficient market theory? a. Fundamental analysis does not help generate abnormal returns. b. Technical analysis is worthless in identifying mispriced stocks. c. Stock prices response to firms’ earnings announcements gradually. d. Mutual fund managers do not beat the market on average.

III. (3pts) A random walk occurs when a) Stock price changes are random but predictable. b) Stock prices respond slowly to both new and old information. c) Past information is useful in predicting future prices. d) Future price changes are uncorrelated with past price changes.

IV. (3pts) Which of the following statements is true about the efficient market hypothesis? a. It implies a rational market. b. It implies that everyone makes zero profit from trading. c. It implies perfect forecasting ability. d. It implies that prices do not fluctuate.

V. (3pts) Mark thinks that there is an interesting paradox of the efficient market hypothesis. If the market believes that prices reflect all information, investors will stop seeking mispriced securities. This may lead to more mispriced stocks and more inefficiency. However, if the market believes that inefficiency still exists, the competition of trying to be the first to find mispriced securities will make markets more efficient. Do you agree with Mark? Why or why not? Please briefly comment.

Paper For Above instruction

The questions outlined delve into key concepts of market efficiency, including the implications and evidence that challenge or support different forms of the Efficient Market Hypothesis (EMH). This analysis explores whether markets are truly efficient and how evidence from empirical studies supports or refutes specific hypotheses.

Question I probes the weak form of EMH by questioning whether technical analysis can generate abnormal profits. The ability of analysts to identify mispriced stocks through charts (option a) directly contradicts weak form EMH, which posits that past prices cannot predict future prices. Mutual fund performance, often examined in relation to market efficiency, aligns with weak form EMH when funds do not outperform the market on average (option b). The fact that some investors can earn abnormal profits (option c) suggests market inefficiencies, though not necessarily contradicting weak form EMH if only a few can do so. Lastly, the autocorrelations not being significantly different from zero (option d) supports the idea that past price movements do not predict future returns, consistent with weak form EMH.

Question II assesses the semi-strong form of EMH, which asserts that all publicly available information is reflected in stock prices. Evidence that stock prices respond gradually to earnings announcements (option c) challenges the semi-strong form, which expects immediate incorporation of such information. If fundamental analysis does not help in generating abnormal returns (option a), it suggests that all publicly available information is already priced, supporting semi-strong efficiency. That mutual funds do not outperform the market (option d) aligns with EMH but does not specifically challenge semi-strong form, whereas technical analysis being worthless (option b) relates more to the weak form. Therefore, the strongest evidence against semi-strong EMH is the gradual response to earnings (option c).

Question III explains the concept of a random walk, where future prices are independent of past prices. If stock price changes are uncorrelated with past price changes (option d), this supports the random walk hypothesis, aligning with EMH. Conversely, stock prices responding slowly or being predictable defies the random walk condition, indicating potential market inefficiencies.

Question IV evaluates the core of EMH, emphasizing its implications. EMH implies a rational market (option a) because prices reflect all available information, which assumes rational investor behavior and market mechanism. It does not suggest zero profits for everyone (option b), nor guarantee perfect forecasting (option c), and certainly does not imply prices are static (option d). Therefore, the most accurate statement is that it implies a rational market.

Question V presents a paradox regarding market efficiency. Mark's paradox suggests that when investors believe prices fully reflect all information, they stop searching for mispriced securities, potentially leading to inefficiencies. Conversely, if investors believe inefficiencies persist, their competitive efforts to identify mispricings could improve market efficiency. This paradox highlights the dynamic tension between beliefs and behaviors, influencing actual market efficiency. I concur partially; excessive complacency can reduce efficiency, but active competition tends to enhance it, although behavioral biases often complicate this process.

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