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Theory- Class 4
Market Efficiency
45
Accounting
Graduate
02/12/2015

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Cards

Term
What is the Certainty Equivalent?
Definition
The point of break even-- Equality
Term
What is Market Efficiency?
Definition
Relationship between security prices and information – is there a relationship?
Term
An Efficient Market fully reflects what information about prices?
Definition
All information
Term
What are the three hierarchies of "all information"?
Definition
- Strong Form
- Semi-Strong Form
- Weak Form
Term
Strong Form
Definition
Security prices reflect ALL information- Private and Public info
Term
Semi- Strong Form aka " market efficiency"
Definition
Security prices reflect ALL information made publicly available
Therefore, it is not based on all information
Term
Weak Form
Definition
Security prices do not reflect ALL information made publicly avaiable
- Anomalies
Term
Should past stock prices with weak form be used to predict current prices?
Definition
No because it is based on only some information
Term
Should information with weak form, based in markets outside of the U.S,. be used?
Definition
No..although china is getting better
Term
Does strong form normally exist?
Definition
NAH
Term
Characteristics of an Efficient Market
Definition
- Reflect public information at all times
- FULLY reflect public information at all times
- All information is immediately impounded
- Efficient markets are a "fair game"-- cannot earn excess returns
Term
What is the normal rate of return?
Definition
8-10%
Term
Rational Investing reflects what type of investor?
Definition
The average, risk averse investor
Term
Security prices are based on the ___ of the individual investors consistent with fair game?
Definition
Margin aka their "collective decision"
Term
What are some reasons investors make different buying decisions?
Definition
- Difference in risk preference
- Different information available
- Different spending habits
Term
Accounting competes with other sources of information such as...
Definition
Term
When individual investors make errors, how do these errors affect the market?
Definition
They are averaged out on the market level-- therefore, nothing really happens.
Term
What were the FASB objectives in Beaver 1973 research?
Definition
- Full disclosure of accounting principles
- Attempted to disclose more information regarding cash flows
- Substance over form
Term
What is more important to an investor- recognition or realization?
Definition
Recognized!
Term
Financial statements protect ___
Definition
Individual investors, especially naiive ones
Term
What is the role of accounting according to Beaver?
Definition
- Increase public information
- Improve upon the market
- Prevent abnormal (excess) returns due to private information - Limit insider info and limit superior info
Term
What is each party concerned:
- Investors:
- Financial Reporting Regulators:
- Management:
-Auditors:
- Information intermediaries:
Definition
- Investors: understanding investing behavior-- what will make them money
- Financial Reporting Regulators: That investors have the information they need to make decisions
- Management: SH wealth-- stewardship role
-Auditors: Liability, resource allocation, accrual accounting
- Information intermediaries: That the information is accurate and the processing is correct
Term
What is a fully informative share price?

Does this exist in the real world? why?

Who discovered this?
Definition
Fully reflects all public information (semi-strong form)

No, because there is a logical inconsistency-- if share prices were fully informative, the market would explode. There would be no losers

Grossman (1976)
Term
Why do share prices not self-destruct? (2 reasons)
Definition
1. Noise trading
2. Share prices are only partially informative
Term
What is meant by Noise Trading?

What does noise trading create?
Definition
Noise traders are traders who attempt to deviate the price from the fully informative price. This introduces a random component to the share price

A need to constantly gather information, a need for full disclosure.
Term
What is the Expected Value of Noise trading?
Definition
ZERO
Term
The Iowa Electronic Markets is what type of market?
Definition
Small-scale, real-money futures markets where contract payoffs depend on economic and political events such as elections
Term
The Iowa Electronic Markets are affected dramatically by what factors?
Definition
Individuals trading on beliefs
Term
Information Asymmetry is caused by what?
Definition
Investors knowing both Public and Private (insider) information
Term
Who causes Information Asymmetry?
Definition
- Inside Management
- Sophisticated investors vs. naiive investors
Term
What does asymmetry lead to?
Definition
Information Risk-- Incomplete (unfair) markets and opportunities for insiders to profit

Moral Hazards

Adverse selection
Term
What is the meaning of Moral Hazard (caused by Asymmetry)?
Definition
-Individuals have an information advantage and use it to their benefit

- Shirking: Managers provide less than best effort

- Insider trading
Term
What is the meaning of Adverse Selection (caused by Asymmetry)?
Definition
Investors make decisions in their own best interest
Term
What are the impacts of insider information on share trading?
Definition
- Market Withdraw: investors leave the market
- Price Protect: dealing with someone with inside information you’re going to pay way less
Term
Lemons problem by Akeroff (1970) tested the used car market in hopes of finding information about ___
Definition
Adverse Selection
Term
What were the findings of the Lemons problem by Akeroff (1970) (testing the used car market)
Definition
- Sellers know more about the used car than the buyer
- Buyers bid prices down on all used cars
- Good used cars are not put on the market
- Market is dominated by "lemons"
- Further downward price pressure
Term
What is the effect of information risk (estimation risk) on share prices?
Definition
- drives price down to a discounted amount
Term
How can we control information risk?
Definition
- Implement laws regarding insider trading
- Disclose all information with financial reporting-- disclose MORE
- Make fundamental (private information) not occur
Term
GM example:
Definition
Term
Under the decision theory, investors will choose the alternative with the highest expected ___
Definition
Utility
Term
Rational investors are most offten assumed to be
Definition
Risk averse
Term
Under Bayes Theorem, what is a likely reason that the main diagonal probabilities are high?
Definition
Ideal conditions are nearing what is being acheived.
Term
A table that provides the objective probability of each possible financial statement evidence item conditional on each state of nature is referred to as ...
Definition
An Information system
Term
Probabilities that are revised following receipt of new accounting information are referred to as ...
Definition
Posterior Probabilities
Term
Highly informative financial statements are...? (3 things)
Definition
- Transparent
- Accurate
- Of a high quality
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