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Chapter 7: Q.7 (page 209)

Suppose that you decide to play a game. You buy stock by throwing a dice a few times, using that method to select which stock to buy. After ten months you calculate the return on your investment and the return earned by someone who followed 鈥渆xpert鈥� advice during the same period. If both returns are similar, would this constitute evidence in favor of or against the efficient market hypothesis?

Short Answer

Expert verified

The evidence does not support the efficient market hypothesis.

Step by step solution

01

Efficient market hypothesis :

It refers to the notion that states that an investment cannot outperform the market. It is impossible for an investor to outperform the market in terms of share price since the stock price would have already risen based on the investor's future predictions.

02

Explanation :

The evidence does not support the efficient market hypothesis. According to the efficient market hypothesis, stock information is represented solely in the stock price, and it is impossible for an investor to outperform the market.

It can be coincidental if someone obtains the same result by simply throwing the dice as someone who seeks expert assistance. It is not in support of the efficient market theory since future rewards may differ for both people.

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Most popular questions from this chapter

In the late 1990s, as information technology advanced rapidly and the Internet was widely developed, U.S. stock markets soared, peaking in early 2001. Later that year, these markets began to unwind and then crashed, with many commentators identifying the previous few years as a 鈥渟tock market bubble.鈥� How might it be possible for this episode to be a bubble but still adhere to the efficient market hypothesis?

Visit the Bloomberg Markets website at www.bloomberg .com/markets/stocks. Their interactive graph allows you to see cumulative returns for individual stocks as well as market indices. Over the last five years, which of the three indices appears the most volatile鈥撯�搕he S&P 500 (SPX:IND), the Dow Jones Industrial Average (INDU:IND), or the NASDAQ Composite (CCMP:IND)? Which index would have been the best investment if compounded over the last five years?

Some economists think that central banks should try to prick bubbles in the stock market before they get out of hand and cause later damage when they burst. How can monetary policy be used to prick a market bubble? Explain using the Gordon growth model.

鈥淎n efficient market is one in which no one ever profits from having better information than the rest of the market participants.鈥� Is this statement true, false, or uncertain? Explain your answer.

If you read in the Wall Street Journal that the 鈥渟mart money鈥� on Wall Street expects stock prices to fall, should you follow that lead and sell all your stocks?
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