ACCT 455
Development of Accounting Thought
Lecture 9. Efficient Securities Markets (II)
Prof. Guang Ma
McGill University
Review of Market Efficiency
Efficient Market Hypothesis
In an efficient capital market, prices fully and instantaneously
reflect all available information.
1. Three forms: Weak, Semi-Strong, and Strong.
2. Efficiency is a dynamic equilibrium.
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Accounting Implications of Securities Market Efficiency
• Accounting policies do not matter (unless cash flow effects)
• “Naı̈ve” investors are price-protected
• Accountants in competition with other information providers
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Capital Asset Pricing Model (CAPM)
E [Ri ] = Rf + βi (E [RM ] − Rf )
• Ri is firm i’s return
• E stands for expectation
• Rf is risk-free interest rate
• RM is the market return
E [Pt+1 + Dt+1 ] − Pt
• E [Ri ] =
Pt
Cov (Ri , RM )
• βi =
Var (RM )
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Role of Accounting Information
How does accounting information affect share price?
• By affecting the expectation of dividends E [Dt+1 ]
• By affecting the estimation of βi : the estimation risk
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Estimating βi
Estimating βi Based on Historical Price Data
Assume:
• Stock price is determined based on CAPM
• The market is efficient (in semi-strong form)
Then the observed real-life data of firm return Ri and market
return RM has the following relation:
Rit = αi + βi RMt + εit
• We can use an OLS regression to estimate βbi
• This version of CAPM is called the ”market model”
• The expected return, therefore, can be expressed as
α
bi + βbi RMt
• The residual, εit , is called ”abnormal return”
• The average (expected) abnormal return is zero, E [εit ] = 0
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Sources of Data
Accounting and stock price data can be found at:
• Bloomberg terminal
• Finance Lab - 3rd floor, McLennan Library Building (M3-53B)
• WRDS (https://wrds-www.wharton.upenn.edu/)
• EDGAR
(https://www.sec.gov/edgar/searchedgar/companysearch.html)
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Commonly Used Statistical Software
• R (https://www.r-project.org/) or RStudio
(https://www.rstudio.com/)
• Stata
• SAS
• Python (https://www.python.org/)
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In-Class Exercise
In-Class Exercise: Problem 13, Chapter 3
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In-Class Exercise: Problem 13, Chapter 3
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In-Class Exercise: Problem 13, Chapter 3
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In-Class Exercise: Problem 13, Chapter 3
Part A:
E [U(a1 )] = 0.5 ×
p
√
1, 225 + 0.5 × 0
= 0.5 × 35 = 17.5
√
√
E [U(a2 )] = 0.5 × 361 + 0.5 × 225
= 0.5 × 19 + 0.5 × 15 = 17
• Stephen should take a1 and invest in AB Ltd.
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In-Class Exercise: Problem 13, Chapter 3
Part B:
From Bayes’ theorem, Stephen’s posterior probability of high performance for
XY Ltd. is:
P(GN|High)P(High)
P(GN)
P(GN|High)P(High)
=
P(GN|High)P(High) + P(GN|Low )P(Low )
0.5 × 0.6
=
= 0.55
0.5 × 0.6 + 0.5 × 0.5
P(High|GN) =
Thus,P(Low |GN) = 1 − 0.55 = 0.45
√
√
E [U(a2 )] = 0.55 × 361 + 0.45 × 225
= 0.55 × 19 + 0.45 × 15 = 17.2
• E [U(a1 )] stay unchanged, 17.5
• Therefore, Stephen should still take a1 and invest in AB Ltd.
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In-Class Exercise: Problem 13, Chapter 3
Part C:
Based on the new information system, Stephen’s posterior probability of high
performance for XY Ltd. is:
P(GN|High)P(High)
P(GN)
P(GN|High)P(High)
=
P(GN|High)P(High) + P(GN|Low )P(Low )
0.5 × 0.8
=
= 0.8
0.5 × 0.8 + 0.5 × 0.2
P(High|GN) =
Thus,P(Low |GN) = 1 − 0.8 = 0.2
√
√
E [U(a2 )] = 0.8 × 361 + 0.2 × 225
= 0.8 × 19 + 0.2 × 15 = 18.2
• E [U(a1 )] stay unchanged, 17.5
• Therefore, Stephen should still now switch to a2 and invest in XY Ltd.
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Discussions
Comparability
The IASB/FASB Framework ( Section 3.7.1 ) includes
comparability as an enhancing characteristic of financial
information.
• If securities markets are efficient, are there any benefits of
comparability in stock valuation? Why
• In reality, can comparability affect stock prices? Why?
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