Active vs. Passive Fund Management

Topics: Stock market, Fundamental analysis, Investment Pages: 19 (7029 words) Published: April 26, 2008


To sum up, based on the discussion above, it seems that for the US market, it appeared to be working under a weak-form of inefficient market considering market anomalies of momentum effects and pricing-earning ratio and intrinsic measure anomalies. However, for Australia market, due to the characteristics difference of Australia market, the portfolio of Australian shares are consistent with the weak-form of market efficiency, however, it does not apply to the individual stocks. Besides, no intrinsic measure anomalies were found for the long horizon. Overall, Australia market is more efficiency compared to US market in terms of weak-from of market efficiency.

In addition, after examining the small firm in January effect anomaly, book to market ratio anomaly and post earnings announcement price drift anomaly, we could see that Australian market especially for small firms was influenced by January effect, book to market ratio and post earnings announcement anomaly, which indicate market inefficiency of Australia market. On the other hand, for the US market, the last three anomalies all applied to US market also, and it seems that US market is also not market efficiency.

An efficient market exists when the stock price fully reflects all the information available . There are several ways to test whether the market is efficient. The main tests include event study, the patterns in stock return, predictors of broad market return, test of anomalies and the inside information . These tests are conducted by using risk models to calculate the excess return of the market , the market is said to be efficient if there is no excess return to be found .

Event study exams the influence on stock price by a specific event and a single-index model is used : rt = a + brmt + et => et = rt –( a + brmt )
rt : stock return during the period t
a : average rate of return during period t with no market return brmt : sensitivity to market return
et : part of stock return due to firm-specific event
And we call et abnormal return.

There are also other tests, such as patterns in stock return and predictors of broad market return which are early tests for the market efficiency and are included in the weak form tests .

The first test is conducted by exam the past stock prices to find the trend . It will need to calculate the serial correlation of stock market return . If it is positive serial correlation, then it means what followed by the positive returns is a positive return, otherwise, it is a negative return . There are problems associated with this test. For the short horizons, a research conducted by Conrad and Kaul and Lo and Mackinlay found that the correlation coefficient is quite small for the weekly return which suggested that there is no strong evidence of the existence of patterns in stock returns over short horizons . However, for the long run, researchers do find that it tends to have a negative correlation coefficient .

The second test is based on the variables such as dividend/price ratio, earnings yield, and spread between yields on corporate bonds, and using these variables to predict market returns . If we can say that market returns are predicted by predicting risk- adjusted abnormal returns then probably the market is inefficient . However, the difficulty here is uncertainty about whether the return we get is result from the predictability by using the indicator in risk premium or risk- adjusted abnormal returns .

Test of anomalies are included in semi strong tests . These tests are normally conducted by applying the CAPM model that is used to adjust the risk . That is, the risk adjusted returns are gained by testing both risk adjustment and market efficiency hypothesis .

There are several examples of anomalies. The small firm in January Effect is about the effect of size . It found that smallest sized firms tend to have a higher...
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