Capital Markets, Investment and Finance

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Capital Markets, Investment and Finance Assignment 2009/ 2010

“No one can consistently predict either the direction of the stock market or the relative attractiveness of individual stocks and thus no one can consistently obtain better overall returns than the market. And while there are undoubtedly profitable trading opportunities that occasionally appear, these are quickly wiped out once they become known. No one person or institution has yet to produce a long-term, consistent record of finding money-making, risk adjusted individual stock trading opportunities, particularly if they pay taxes and incur transaction costs” (A Random Walk Down Wall Street, p.245, Burton G. Malkiel).

Required
Discuss the above quotation in the light of the overwhelming evidence of persistent stock market anomalies, for both world wide, emerging and developed markets. Is it possible to harness these anomalies as part of an investment strategy?

Group Members:
Abdul Bagadir
Yazid Al-Yazeedi
Haitham Al-Lawati
Talha Khan
Imam Hussain
Ismail Patel

Total Words: 2557

“No one can consistently predict either the direction of the stock market or the relative attractiveness of individual stocks and thus no one can consistently obtain better overall returns than the market. And while there are undoubtedly profitable trading opportunities that occasionally appear, these are quickly wiped out once they become known. No one person or institution has yet to produce a long-term, consistent record of finding money-making, risk adjusted individual stock trading opportunities, particularly if they pay taxes and incur transaction costs” (A Random Walk Down Wall Street, p.245, Burton G. Malkiel).

Required
Discuss the above quotation in the light of the overwhelming evidence of persistent stock market anomalies, for both world wide, emerging and developed markets. Is it possible to harness these anomalies as part of an investment strategy?

“An anomaly is an occurrence that cannot be explained by a prevailing theory” (Al-Loughani et al, 2005). Stock market anomalies are methodical variations in stock price related to specific times of the calendar. According to Schwertz, anomalies are pragmatic results that seem to be inconsistent with maintained theories of asset pricing behaviour. They indicate either market inefficiency or inadequacies in the underlying asset-pricing model.

“Many empirical tests were made to demonstrate the information efficiency of stock market, by contrast, much has been written with the aim of demonstrating their inefficiency by identifying systematic variations in stock prices related to the calendar of the civil year” (Barone 1989).

Anomalies are changes in returns that are not consistent with the Efficient Market Hypothesis (Al-Loughani et al 2005). In order to research anomalies one would also have to explain the efficient market hypothesis.

According to Eugene Fama (1965) who developed the efficient market hypothesis, “an efficient market is a market where there are a large number of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words in an efficient market at any point in time, the actual price of a security will be a good estimate of its intrinsic value."

An efficient market is one where current prices are an unbiased estimate of the true value of the investment. In an efficient market current prices fully reflect all available information and its fair value. The market value is the fair price...
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