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Chapter 2: Question 8-11I (page 259)

Which of the following most appears to contradict the proposition that the stock market is weakly efficient? Explain.

a. Over 25% of mutual funds outperform the market on average.

b. Insiders earn abnormal trading profits.

c. Every January, the stock market earns abnormal returns.

Short Answer

Expert verified

The correct answer is ‘c’.

Step by step solution

01

Definition

A condition in which an asset’s price is not truly reflected with all the available information is a typical feature of an inefficient Market.

02

Explanation

If the stock market would have been weakly efficient, it would not earn abnormal returns, every January on the premise that the stock prices would increase in January after sale of underperformed stocks towards the year end. The above hypothesis i.e. “selling high” and “buying low” is a classic filter rule which appears to most contradict the hypothesis of weak form of efficient market. Thus the correct answer is c.

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Most popular questions from this chapter

“Highly variable stock prices suggest that the market does not know how to price stocks.” Respond.

Which of the following statements is true? Explain.

a. It is possible that the APT is valid and the CAPM is not.

b. It is possible that the CAPM is valid and the APT is not.

Growth and value can be defined in several ways. Growth usually conveys the idea of a portfolio emphasizing or including only companies believed to possess above-average future rates of per-share earnings growth. Low current yield, high price-to-book ratios, and high price-to-earnings ratios are typical characteristics of such portfolios. Value usually conveys the idea of portfolios emphasizing or including only issues currently showing low price-to-book ratios, low price-to-earnings ratios, above-average levels of dividend yield, and market prices believed to be below the issues’ intrinsic values.

a. Identify and provide reasons why, over an extended period of time, value-stock investing might outperform growth-stock investing.

b. Explain why the outcome suggested in ( a ) should not be possible in a market widely regarded as being highly efficient.

Suppose that, after conducting an analysis of past stock prices, you come up with the following observations. Which would appear to contradict the weak form of the efficient market hypothesis? Explain.

a. The average rate of return is significantly greater than zero.

b. The correlation between the return during a given week and the return during the following week is zero.

c. One could have made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

d. One could have made higher-than-average capital gains by holding stocks with low dividend yields.

At a cocktail party, your co-worker tells you that he has beaten the market for each of the last three years. Suppose you believe him. Does this shake your belief in efficient markets?
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