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stockholders: those who hold stock in a corporation residual claimant: stockholder receives whatever remains after all other claims against the firm’s assets have been satisfied dividends: payment made periodically, usually every quarter, to stockholders The One-Period Valuation Model P0 = (Div1)/(1 + ke) + (P1)/(1 + ke) The Generalized Dividend Valuation Model P0 = (Div1)/(1 + ke) + (Div2)/(1 + ke)2 + … + (Divn)/(1 + ke)n + (Pn)/(1 + ke)n generalized dividend model: P0 = (Div1)/(1 + ke) + (Div2)/(1 + ke)2 + … Gordon Growth Model P0 = [Div0 x (1 + g)]/(1 + ke) + [Div0 x (1 + g)2]/(1 + ke)2 + … + [Div0 x (1 + g)¥]/(1 + ke)¥ P0 = [Div0 x (1 + g)]/(ke – g) = Div1/(ke – g) 1. Dividends are assumed to continue growing at a constant rate forever. 2. The growth rate is assumed to be less than the required return on equity. |
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APPLICATION Monetary Policy and Stock Prices APPLICATION The September 11 Terrorist Attaches, the Enron Scandal, and the Stock Market |
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adaptive expectations: expectations are formed from past experience only; e.g., average of past inflation rates rational expectations: expectations will be identical to optimal forecasts (the best guess of the future) using all available information Even though a rational expectation equals the optimal forecast using all available information, a prediction based on it may not always be perfectly accurate. Two reasons why expectations may fail to be rational: 1. People might be aware of all available information but find it takes too much effort to make their expectation the best guess possible. 2. People might be unaware of some available relevant information, so their best guess of the future will not be accurate. Formal Statement of the Theory Xe = Xof Rationale Behind the Theory efficient market hypothesis: application of the theory of rational expectations to financial markets Implications of the Theory 1. If there is a change in the way a variable moves, the way in which expectations of this variable are formed will change as well. 2. The forecast error of expectations will on average be zero and cannot be predicted ahead of time. |
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R = (Pt+1 – Pt + C)/Pt Re = (Pt+1e – Pt + C)/Pt Pt+1e = Pt+1of Re = Rof Re = R* Re = R* Rof = R* Current prices in a financial market will be set so that the optimal forecast of a security’s return using all available information equals the security’s equilibrium price. Rational Behind the Hypothesis Rof > R* ® Pt ® Rof ¯ Rof < R* ® Pt ¯ ® Rof until Rof = R* Stronger Version of the Efficient Market
Hypothesis market fundamentals: items that have a direct impact on future income streams of the securities |
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Evidence in Favor of Market Efficiency Performance
of Investment Analysts and Mutual Funds Having performed will in the past does not indicate that an investment adviser or a mutual fund will perform well in the future. Do
Stock Prices Reflect Publicly Available Information? Random-Walk
Behavior of Stock Prices random walk: describes the movements of a variable whose future changes cannot be predicted because, given today’s value, the variables is just as likely to fall as to rise Future changes in stock prices, should, for all practical purposes, be unpredictable. Technical
Analysis APPLICATION Should Foreign Exchange Rates Follow a Random Walk? Evidence Against Market Efficiency Small-Firm
Effect January
Effect Market
Overreaction Excessive
Volatility Mean
Reversion mean reversion: stocks with low returns today tend to have high returns in the future and vice versa New
Information is Not Always Immediately Incorporated into Stock Prices Overview of the Evidence on the Efficient Market
Hypothesis APPLICATION Practical Guide to Investing in the Stock Market How
Valuable Are Published Reports by Investment Advisers? Should
You Be Skeptical of Hot Tips? Do Stock
Prices Always Rise When There is Good News? Stock prices will respond to announcements only when the information being announced is new and unexpected. Efficient
Market Prescription for the Investor |
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If there is a change in the way a variable moves, there will be a change in the way expectations of this variable are formed as well. APPLICATION What Do the Black Monday Crash of 1987 and the Tech Crash of 2000 Tell Us About Rational Expectations and Efficient Markets? bubble: situation in which the price of an asset differs from its fundamental market value |
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behavioral finance: applies concepts from other social sciences such as anthropology, sociology, and, particularly, psychology to understand the behavior of securities markets QUESTIONS AND PROBLEMS: 1, 3, 5, 11, 13, 15 |
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Disclaimer: pages.slu.edu is a service of Saint Louis University, Saint Louis University does not control, monitor or guarantee the information contained in these sites. For more information » |