Chapter 08 – The Efficient Market Hypothesis
1. The correlation coefficient should be zero. If it were not zero, then one could use
returns from one period to predict returns in later periods and therefore earn abnormal
2. Over the long haul, there is an expected upward drift in stock prices based on their fair
expected rates of return. The fair expected return over any single day is very small (e.g.,
3. No, this is not a violation of the EMH. Microsoft’s continuing large profits do not imply
4. No. The notion of random walk naturally expects there to be some people who beat the
5. b. This is the definition of an efficient market.
6. d. It is not possible to offer a higher risk-return trade off if markets are efficient.
7. Strong-form efficiency includes all information: historical, public, and private.
8. Incorrect. In the short term, markets reflect a random pattern. Information is constantly
flowing in the economy and investors each have different expectations that vary
9. c. If the stocks are overvalued, without regulative restrictions or other constraints on the
trading, some investors observing this trend would be able to form a trading strategy to
10. c. This is a filter rule, a classic technical trading rule, which would appear to contradict
the weak form of the efficient market hypothesis.
11. c. The P/E ratio is public information so this observation would provide evidence
against the semi-strong form of the efficient market theory.
12. No, it is not more attractive as a possible purchase. Any value associated with dividend
predictability is already reflected in the stock price.
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13. No, this is not a violation of the EMH. This empirical tendency does not provide
investors with a tool that will enable them to earn abnormal returns; in other words, it
14. While positive beta stocks respond well to favorable new information about the
economy’s progress through the business cycle, the stock’s returns should be
15.
a. Consistent. Half of all managers should outperform the market based on pure
luck in any year.
b. Violation. This would be the basis for an “easy money” rule: Simply invest with
16. An anomaly is considered an EMH exception because there are historical data to
substantiate a claim that says anomalies have produced excess risk-adjusted abnormal
returns in the past. Several anomalies regarding fundamental analysis have been
17. Implicit in the dollar-cost averaging strategy is the notion that stock prices fluctuate
around a “normal” level. Otherwise, there is no meaning to statements such as “when
18. The market responds positively to new news. If the eventual recovery is anticipated,
19. You should buy the stock. The firm’s management is not as bad as everyone else
20. The market may have anticipated even greater earnings. Compared to prior
expectations, the announcement was a disappointment.
21. This is not a violation of EMH. A possible explanation might be that the market index,
22. The negative abnormal returns (downward drift in CAR) just prior to stock purchases
suggest that insiders deferred their purchases until after bad news was released to the
23.
a. If a shift were actually predictable, it would be a violation of EMH. Such shifts
would be expected to occur as a result of a recession, but the recession is not
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Chapter 08 – The Efficient Market Hypothesis
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Answer:
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Chapter 08 – The Efficient Market Hypothesis
b.
(i) Technical analysis involves the search for recurrent and predictable patterns in
stock prices in order to enhance returns. The EMH implies that technical analysis
is without value. If past prices contain no useful information for predicting future
prices, there is no point in following any technical trading rule.
Chapter 08 – The Efficient Market Hypothesis
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