FIN 352 – Professor Dow

Common meaning: Markets always get
things right.

Economic: Markets allocate resources to
their most efficient uses.

Financial: Markets are informationally
efficient.

Asset prices fully incorporate all available
information.

What does all mean?
What does fully mean?


How quickly is new information incorporated?

What information is incorporated?

Is information incorporated correctly?

Does extraneous information matter?

The government announces that Boeing will
get a contract to build tankers.

How quickly does this news get reflected in
Boeing’s stock price?

Can you be the first to the market and buy
Boeing stock before the price increases?

Say that the government announces some
information about the contract, provides
other information in reports and keeps some
other information private.

What information do people pay attention to?

Can you gain by using information that is
available and that others ignore?

The government releases information about
how many planes they intend to buy and at
what price.

Do investors correctly forecast how that will
affect Boeing’s profitability and price?

Can you do a better job in forecasting?

If there wasn’t any new information about
Boeing profitability, might investors still
change their opinion about Boeing stock?

Could you take advantage of this behavior?

If markets get the price right, no point in
trying to beat the market

Incentives to make money

Paradox: impossibility of perfectly efficient
markets.

Psychological biases: behavioral finance.

“Markets can remain irrational longer than
you can remain solvent”

Do investors beat the market in practice?
 Luck vs. Skill.

Predictability of stock returns?

Details of tests in next lecture.

The market is roughly efficient – stock prices are
hard to predict.

The market is not perfectly efficient.

More efficient with some kinds of information
than others.
 Quickly incorporates new information.
 Better at comparing companies rather than
determining overall levels.
 Irrational exuberance.

If you think markets are inefficient,

you should be able to explain what the
inefficiency is and why you can take
advantage of it.

Otherwise, passive investing is the better
strategy.