第十九屆亞太財務經濟會計及管理會議
The Efficient Markets Hypothesis
The Demise of the Demon of Chance?
Stephen J. Brown
NYU Stern School of Business
The 19th Annual Conference on Pacific Basin Finance, Economics,
Accounting, and Management
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
 Asset pricing theory
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
 Asset pricing theory
 Efficient Markets Hypothesis
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
 Asset pricing theory
 Efficient Markets Hypothesis
 Corporate finance
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
 Asset pricing theory
 Efficient Markets Hypothesis
 Corporate finance
 Derivative Securities, Fixed Income Analysis
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
 Asset pricing theory
 Efficient Markets Hypothesis
 Corporate finance
 Derivative Securities, Fixed Income Analysis
 Market Microstructure
第十九屆亞太財務經濟會計及管理會議
Major developments over last 40
years
 Portfolio theory
 Asset pricing theory
 Efficient Markets Hypothesis
 Corporate finance
 Derivative Securities, Fixed Income Analysis
 Market Microstructure
 Behavioral Finance
第十九屆亞太財務經濟會計及管理會議
The EMH was responsible for the GFC
“Neo-liberal policy prescriptions flow from the core theoretical belief in the
superiority of unregulated markets - particularly unregulated financial markets.
These claims ultimately rest on the "efficient-markets hypothesis", which, in its
strongest form, claims that financial-market prices, like stock-market prices,
incorporate all available information, and therefore represent the best possible
estimate of asset prices. It follows, therefore, that if markets are fully efficient
and prices fully informed, there is no reason to believe that asset-price
bubbles are probable; and if these do occur, markets will self-correct; and that
there is therefore no justification for government intervention to stop them
occurring”
Kevin Rudd The Monthly 42 (February 2009)
第十九屆亞太財務經濟會計及管理會議
The EMH was responsible for the GFC
“The incredibly inaccurate efficient market theory was believed in totality by
many of our financial leaders, and believed in part by almost all. It left our
economic and government establishment sitting by confidently, even as a
lethally dangerous combination of asset bubbles, lax controls, pernicious
incentives and wickedly complicated instruments led to our current plight.
‘Surely, none of this could be happening in a rational, efficient world,’ they
seemed to be thinking. And the absolutely worst part of this belief set was that
it led to a chronic underestimation of the dangers of asset bubbles breaking.”
Jeremy Grantham (quoted in the New York Times June 5, 2009)
第十九屆亞太財務經濟會計及管理會議
Grantham’s performance over GFC
Sharpe
Ratio
Alpha (market
benchmark)
Alpha (Fama
French 3 factor)
GMO US Equity Allocation Fund; Class III Shares
-0.284
-0.00288 (-0.94)
-0.00264 (-0.80)
GMO Tobacco-Free Core Fund; Class III Shares
-0.268
-0.00215 (-0.71)
-0.00261 (-0.81)
GMO US Quality Equity Fund; Class VI Shares
-0.245
-0.00113 (-0.31)
-0.00043 (-0.11)
GMO US Quality Equity Fund; Class V Shares
-0.245
-0.00112 (-0.30)
-0.00041 (-0.10)
GMO US Quality Equity Fund; Class IV Shares
-0.246
-0.00116 (-0.31)
-0.00045 (-0.12)
GMO US Quality Equity Fund; Class III Shares
-0.247
-0.00121 (-0.33)
-0.00050 (-0.13)
GMO Tax-Managed US Equities Fund; Class III Shares
-0.318
-0.00473 (-1.62)
-0.00435 (-1.40)
GMO US Growth Fund; Class M Shares
-0.276
-0.00258 (-0.86)
-0.00339 (-1.15)
GMO US Core Equity Fund; Class M Shares
-0.301
-0.00388 (-1.46)
-0.00392 (-1.37)
GMO US Core Equity Fund; Class VI Shares
-0.295
-0.00353 (-1.32)
-0.00355 (-1.23)
GMO US Core Equity Fund; Class IV Shares
-0.295
-0.00357 (-1.33)
-0.00359 (-1.24)
GMO US Core Equity Fund; Class III Shares
-0.296
-0.00362 (-1.36)
-0.00363 (-1.26)
GMO US Intrinsic Value Fund; Class III Shares
-0.353
-0.00736 (-2.44)
-0.00708 (-2.30)
GMO US Small/Mid Cap Growth Fund; Class III Shares
-0.306
-0.00591 (-1.24)
-0.00894 (-2.21)
S&P500 Market -0.236
Data from August 07 – May 09 from CRSP Mutual Funds Database
第十九屆亞太財務經濟會計及管理會議
Efficient Markets Hypothesis
 No trader’s information gives them an advantage
E  rt  | it , t   E  rt  | t   0
 If information zit is already incorporated in price


E rt   E  rt  | t  zit  0
t
第十九屆亞太財務經濟會計及管理會議
Examples of EMH applications


E  rt   E  rt  | t  zt  0
t
 Weak form Efficient Markets Hypothesis
1

zt  0
1

 Example: trading rule tests
 Does active management outperform passive benchmark?
1

 Example: Event studies
zt  0
 What information releases are material to investors? 
1
 Semi-strong form EMH
 Empirical asset pricing
sell
hold
buy
bad news
no news
good news
 Example: Orthogonality condition in GMM
zt  "instruments "
 Can we explain cross sectional dispersion in required return?
第十九屆亞太財務經濟會計及管理會議
Efficient Markets Hypothesis


E  rt   E  rt  | t  zt  0
t
 Tests of Efficient Markets Hypothesis
 Does the market efficiently process information?
 What is information?
 Estimation of parameters
 Does the market efficiently price risk?
 What determines the cross section of expected returns?
第十九屆亞太財務經濟會計及管理會議
Efficient Markets Hypothesis


E  rt   E  rt  | t  zt  0
t
第十九屆亞太財務經濟會計及管理會議
Random Walk Hypothesis


E  rt   E  r  rt  0
第十九屆亞太財務經濟會計及管理會議
Random Walk Hypothesis


E  rt   E  r   rt  E  r   0
“The series looks like a ‘wandering’ one, almost as if
once a week the Demon of Chance drew a random
number from a symmetrical population of fixed
dispersion and added it to the current price to
determine the next week’s price”
Kendall (1953)
第十九屆亞太財務經濟會計及管理會議
Random Walk Hypothesis


E  rt   E  r   rt  E  r   0
 Serial Correlation tests
 Variance ratio tests
第十九屆亞太財務經濟會計及管理會議
Random Walk Hypothesis


E  rt   E  r   rt  rt   0
Zero investment portfolio
 Serial Correlation tests
 Variance ratio tests
 Momentum
第十九屆亞太財務經濟會計及管理會議
Random Walk Hypothesis


E  rt   E  r  rt  0
 Well established statistical properties
 Strong assumption of stationarity
 Time varying conditional expectations not allowed
 Neither necessary nor sufficient for EMH
第十九屆亞太財務經濟會計及管理會議
Trading rule tests of EMH


E  rt   E  rt  | t  zt  0
t
1

zt  0
1

sell
hold
buy
 Timmerman (2007) survey
 Naïve models using past sample means hard to beat
 Recent financial data is most relevant
 Short lived episodes of limited predictability
 Predictability is not profitability
 Necessity: Do not consider all possible patterns of returns
 Sufficiency: Cannot profit if all markets rise and fall together
第十九屆亞太財務經濟會計及管理會議
Examining profitability
 Appearance of short term profitability ..
Portfolio
Nick Leeson
Société Générale Jan 2008
Jérôme
Kerviel
Benchmark
 at the expense of significant downside risk
(Goetzmann et al. 2008)
第十九屆亞太財務經濟會計及管理會議
An important seminal reference …
第十九屆亞太財務經濟會計及管理會議
Trading Rules: Cowles 1933
 Cowles, A., 1933 Can stock market forecasters forecast?
Econometrica 1 309-325
 William Peter Hamilton’s Track Record 1902-1929
 Classify editorials as Sell, Hold or Buy
Eˆ [rt   E  rt  |  t ] t  3.5%
Return on DJI
 Novel bootstrap in strategy space
 1

 t  0
 1

41 sell
74 hold
140 buy
第十九屆亞太財務經濟會計及管理會議
Trading rule predicting sign of excess return
January 1970 - December 2005
Trading rule value
S&P500 value
Factor-augmented AR logit based on prior 120 month rolling window
第十九屆亞太財務經濟會計及管理會議
Cowles Bootstrap
Jan 1970-Dec 2005
Annualized excess fund return
Sharpe ratio of fund
Sharpe ratio of S&P500
Peseran & Timmermann (1992) p-value
Cowles bootstrap p-value
2.203%
0.063
0.049
4.83%
6.32%
第十九屆亞太財務經濟會計及管理會議
Standard Event Study approach
EVENT
rt1
u01 u11u21 …
EVENT
rt2
u02 u12u22 …
EVENT
rt3
u03 u13u23 …
EVENT
EVENT
rt4
u05 u15u25 …
u04 u14u24 …
0
5
10
15
20
25
30
t
第十九屆亞太財務經濟會計及管理會議
Fama Fisher Jensen and Roll
Cumulative residuals around stock
split
Cumulative average residual - Um
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
-30
-20
-10
0
10
20
Month relative to split - m
30
第十九屆亞太財務經濟會計及管理會議
FFJR Redux
Cumulative residuals around stock
split
Cumulative average residual - Um
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
-30
-20
-10
0
10
20
Month relative to split - m
30
第十九屆亞太財務經濟會計及管理會議
Bottom line: is EMH useful?
 For whom is the EMH true?
 Uninformed investors with limited capital?
 Large well informed and well endowed investors?
 Does it have practical implications?
 Benchmark comparisons for fund investors?
 What information is material to investors?
 Useful measures of risk and investment risk premia?
第十九屆亞太財務經濟會計及管理會議
The EMH was not responsible for GFC
 Banks invested in beta, thinking it was alpha
 They borrowed to invest in market risk
 Significant debt exposure at cusp of crisis
 Banks failed to predict the collapse of the market
 A direct implication of the EMH