Two Pillars of Asset Pricing, American Economic Review Flashcards Preview

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Flashcards in Two Pillars of Asset Pricing, American Economic Review Deck (6)
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1

The three EMH forms

1. Strong: prices incorporate all information, public and non-public
2. Semi-strong: prices implement all public information
3. Weak: prices incorporate all information of past price movements

2

The three EMH arguments

1. Investors are rational
2. Irrational investors cancel each other out b/c random
3. Even when they don’t cancel out, arbitreurs take advantage and the irrational make loses

3

What’s the Joint Hypothesis Problem?

1. We need to know WHAT the market is supposed to do to know whether it does it.
2. Less of a problem in short time horizons.
3. Testing EMH we need to make assumptions on the other models (market model, CAPM, ICAPM, etc).

4

Conclusion from Irving Fisher (“Market efficiency”) hypothesis

Expected returns are high when business conditions are poor and low when they are strong.

5

“bubbles”

irrational strong price increase that implies a predictable strong decline.

6

Critique on models related to behavioural finance

The behavioural literature has not put forth a full blown model for prices and returns that can be tested and potentially rejected – the acid test for any model proposed as a replacement for another model.