Which of the following phenomena would be either consistent with or a violation of the Efficient Market Hypothesis? Explain.
Which of the following phenomena would be either consistent with or a violation of the Efficient Market Hypothesis? Explain.
a) Nearly half of all professionally managed stock mutual funds are able to outperform
the S&P 500 in a typical year.
b) Money managers who outperform the market (on a risk-adjusted basis) in one year are
likely to outperform in the following year.
c) Stock prices tend to be predictably more volatile in January than in other months.
Question 3
Suppose that as the economy moves through a business cycle, market risk premiums also change. For example, in a recession when people are concerned about their jobs, risk tolerance might be lower and market risk premiums might be higher. In a booming economy, tolerance for risk might be higher and market risk premiums might fall.
a) Would a predictably shifting market risk premium such as described here be a violation
of the efficient market hypothesis?
b) How might a cycle of increasing and decreasing risk premiums create an appearance
that stock prices “overreact,” first falling excessively during the recession and then
seeming to recover?
Question 4
Shares of small firms with thinly traded stocks tend to show positive CAPM alphas. Is
this a violation of the Efficient Market Hypothesis? Describe a scenario where this would
not be a violation. Then describe a scenario where it is.
Question 5
Firm XYZ just announced an increase in its quarterly earnings, but its stock price fell
substantially. Is there a rational explanation for this phenomenon? That is, why might the
market react negatively to something that on the surface looks like the release of good news?
Answer preview for Which of the following phenomena would be either consistent with or a violation of the Efficient Market Hypothesis? Explain.
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