Flashcards in Two Pillars of Asset Pricing, American Economic Review Deck (6)
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
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
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).
Conclusion from Irving Fisher (“Market efficiency”) hypothesis
Expected returns are high when business conditions are poor and low when they are strong.
irrational strong price increase that implies a predictable strong decline.