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CAPITAL MARKET ANALYSIS: A DICUSSION ON EFFICIENT MARKET HYPOTHESIS. Answer
to Question 1: Efficient Market Hypothesis was firstly ...
Submitted by jackychowkk on July 30, 2006
Category: Business
Words: 3338 | Pages: 14
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Answer to Question 1:
Efficient Market Hypothesis was firstly brought forward by E. Fama in 1960s. Its main believing is in that security prices fully reflect all available information in an efficient market, which allows investors to earn no above average risk-adjusted return (Fama, 1965). Although some technical studies and opportunistic investors have stretched hard in searching for proofs to challenge the efficient market hypothesis, and to prove above average returns could be gained by predicting the future price using the existing information, their efforts result only in finding of the ＆anomalies＊ in the market which are destined to self-destructing in the long run or being proved worthless taken the transaction cost.
Accepting the ideas of efficient market hypothesis and based on the collective effort of Sharpe, Treynor, Lintner, and Mossin (see Perold, 2004), Capital Asset Pricing Model (CAPM) was developed in 1960s as a modified form of Sharpe Ratio in evaluating financial assets returns and prices versus risks in the form of:
E (ri) = rf + 汕i [ E(rm) 每rf ] .
From the CAPM model, Jensen (1968) derive his risk-adjusted measure of portfolio performance (now known as "Jensen's Alpha").The formula given below demonstrates the function of 汐, and is used to determine the excess return (the amount by which the portfolio's actual return deviates from its expected return). Like Treynor, Jenson also considered only the un-diversifiable risk, assuming that the portfolio eliminates the diversifiable risk.
ri = 汐 + rf + 汕i [ E(rm) 每rf ] = 汐 + E (ri)
汐 = ri 每 rf 每 汕i [ E(rm) 每rf ]
汐 here is named as Jensen＊s Alpha, as illustrated in diagram:
This measure indicates the difference between the portfolio's actual return and its expected return. According to efficient market hypothesis, the portfolio return should be on the SML, which means Jensen＊s alpha...
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