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MARKET EFFICIENCY
By: ELROY DIMSON AND MASSOUD MUSSAVIAN
 Marmara University
 Social science
institute
 PhD program of
Accounting and
finance
 Academic year
2011/2012
 Supervised by:
Prof.Dr.: Jale Oran
 Prepared by:
Mohammed Al Ashi
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ELROY DIMSON
 Emeritus Professor
of Finance
 has been an
Associate Editor of
Journal of Finance,
Review of Finance
 A co-designer of the
FTSE 100 index
 PhD, London
Business School,
1979
 THREE
CENTURIES OF
ASSET PRICING
 A brief history of
market efficiency
 Irrational Optimism
2

1. Introduction
 The concept of market efficiency had been
anticipated at the beginning of the century in
the dissertation submitted by Bachelier (1900)
 Bachelier recognises that “past, present and
even discounted future events are reflected in
market price, but WITHOUT apparent relation
to price changes”.
3

…Con. introduction
 and later studies by Working (1934) and
Cowles and Jones (1937) were to show that
US stock prices and other economic series
also share these characteristics. (fluctuate
randomly)
 These studies were largely ignored by
researchers until the late 1950s.
4

2. The Random Walk Model
 (Kendall, 1953) examined 22 UK stock and
commodity price series, however, the results
surprised him. He concluded that:
The data behave almost like rootless series
5

…con. The Random Walk Model
 Osborne (1959)   analyzed US stock price
data out of pure academic interest, presenting
his results to other physicists at the US Naval
Research Laboratory. Osborne shows that
common stock prices have properties parallel
to the movement of molecules. He applies the
methods of statistical mechanics to the stock
market, with a detailed analysis of stock price
fluctuations from the point of view of a
physicist.
6

…con. The Random Walk Model
 Fama’s (1965) doctoral dissertation was
reproduced, in the Journal of Business.
 Fama reviews the existing literature on stock
price behavior, examines the distribution and
serial dependence of stock market returns,
and
 concludes that “this paper has presented
strong and more than enough evidence in
support of the random walk hypothesis.”
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3. The concept of market
efficiency
 Samuelson (1965), whose Proof That
Properly Anticipated Prices Fluctuate
Randomly began with the observation that “in
competitive markets there is a buyer for every
seller. If one could be sure that a price would
rise, it would have already risen.”
 that perform a random walk with no predictable
foregone conclusion.”
8

…con. The concept of market
efficiency
 Fama (1970) assembled a comprehensive
review of the theory and evidence of market
efficiency. Though his paper moves forward
from theory to empirical work, he notes that
most of the empirical work preceded
development of the theory.
 The theory involves defining an efficient
market as one in which trading on available
information fails to provide an abnormal profit.
 A market can be deemed to be efficient
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4. Event studies
 The first event study was undertaken by Fama,
Fisher, Jensen and Roll (1969), though the first
to be published was by Ball and Brown (1968).
 Using the market model or capital asset pricing
model as the benchmark, these event studies
provide evidence on the reaction of share prices
to stock splits and earnings announcements
respectively. In both cases, the market appears to
anticipate the information, and most of the price
adjustment is complete before the event is
revealed to the market.
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5. Strong form efficiency
 until the 1960s there was a gap in knowledge
about the returns achieved by professional
portfolio managers.
 The first such study was Treynor’s (1965)
article in Harvard Business Review on the
performance of mutual funds, closely followed
by Sharpe’s (1966) competitor article.
 Jensen (1968). “on average the funds
apparently were not quite successful enough
in their trading activities to recover even their
brokerage expenses.”
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…con. Strong form efficiency
 Fama (1991) summarises a number of
subsequent studies of mutual fund and
institutional portfolio managers’s performance.
Though some mutual funds have achieved
minor abnormal gross returns before
expenses.
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6. Stock Market Anomalies
 Basu (1977) documented the use of
price/earnings ratios to forecast stock
returns. In a study of 1400 firms over the
period 1956-71, he observes low p/e securities
outperforming their high p/e counterparts by
more than seven percent per year.
 * challenge to CAPM model
13

…con. Stock Market
Anomalies
 literature on earnings-related anomalies was
the survey by Ball (1978). He summarised
twenty studies of earnings and dividends, and
concluded that the collective evidence of
anomalous behaviour was strong.
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Anomalies
 other puzzling observations that present a
challenge to the efficient markets hypothesis. A
observable fact that has not yet been
explained satisfactorily is the negative long-run
performance of new issues,
 Ritter finds that an initial investment in these
shares at the end of the first day of trading
would have generated substantial
underperformance over the following three
years.
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Anomalies
 In addition there is also a literature on stock
market seasonalities, including month-of-the-
year, week-of-the-month, day-of-the-week, and
hour-of-the-day effects
 As discussed in Dimson (1988), some of
these patterns, notably the January seasonal
of small stock returns, may be consistent with
either market inefficiencies or seasonalities in
asset pricing.
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7. Market Microstructure
 Kyle (1985) develops a model in which multiple
orders of variable size are processed at a single
price. His model has three types of traders:
 (1)a single informed trader, (2)several competing
market makers, and (3) uninformed noise traders
who transact randomly.
 Noise traders hide the activities of the informed
trader, whose transactions are organised in such
a way that his private information is reflected
gradually in market prices. The market makers
compete and therefore break even while informed
transactors achieve a profit at the expense of
noise traders.
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8. Finally…….
 The efficient markets model continues to provide a
framework that is widely used by financial economists.
 The importance of the efficient markets hypothesis is
demonstrated by the fact that apparently profitable
investment opportunities are still referred to as
“anomalies”.
 Indeed, Fama (1998) takes issue with the view that
apparent anomalies require new behaviourally based
theories of the stock market. Rather, they are
indicative of a need to continue the search for better
models of asset pricing.
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