Lecture Overview:
- Efficient market hypothesis (EMH)
- Behavioral Finance
Random Walk
- A market where the stock prices move randomly reflects a better functioning stock market.
Random Walk:
The changes in stock price are random and cannot be predicted
- Any predictable changes will be exploited immediately
- Reflected into the current stock price
$P_0~|---------|~P_1$
Efficient Market Hypothesis (EMH)
A financial market is (informationally) efficient when market prices reflect all available information about security value.
- Security prices should fully reflect all available information
- New information should be incorporated into security prices in an instantaneous and unbiased manner
About “efficient”
- Risk-return efficient: best E(r) for a given risk (efficient frontier)
- Informationally efficient: current price is right.