If a firm announces an unexpectedly large cash dividend, the efficient market hypothesis (EMH) would predict which of the following price changes at the announcement? A) An abnormal price change to occur before the announcement. B) No price change. C) A gradual price change to occur for several weeks after the announcement. D) An abnormal price change to occur at the time of the announcement. Your answer: A was incorrect. The correct answer was D) An abnormal price change to occur at the time of the announcement. Market efficiency assumes investors adjust their estimate of security prices rapidly to reflect their interpretation of the new information received. Market efficiency also assumes that new information comes to market randomly and is available to all investors at the same time. Therefore, the price should not be reflected prior to the announcement. My reasoning is that in strong form, price reflects public and private info… assuming there is a time gap between board decision to pay unexpected dividend and actual announcement, this info is private but still should reflect in price… Any comments pls…
My take on this one is that the question is trying to ask about semi-strong form market efficiency as it is more accepted than strong form market efficiency. This would lead to to the previously unexpected dividend to be immediately seen in the pricing of the stock on being seen by the market. I would have chosen D as I think strong form market efficiency is bit of a stretch - we still charge people with insider trading - that assumes that there is still a benefit to insider information. Just my view on it
D is a better choice. Your reasoning about A is good, but the problem is that the statement “…before the announcement” does not necessarily say a day or two before the announcement…the question could mean weeks or months before the announcement, in which case we cannot assume that insiders would buy, etc. We also cannot assume that insiders will necesarily buy…in fact, most insiders don’t buy.
When the level of efficiency is not stated, my sense is that it’s best to assume semi strong-form (adjusts to public information). First, it’s the intermediate level. More important, prices quickly reflecting all available public info is what most people immediately assume when asked about this. Strong-form efficiency is mostly a straw man set up to define the end-point of a continuum starting at weak form and running through SS form.
Another bad schweser question…
D is a better option.
> Strong-form efficiency is mostly a straw man set up to define the end-point of a continuum starting at weak form and running through SS form. I’m not sure that it’s a correct way to view weak form as the other end of this. If strong form is about a market that you can’t do anything to take advantage of, the other end would be a market which is easily manipulated. But that’s not what weak form is. Comments?
Dreary: I should always be more careful when posting in the wee hours o the mornin. I should have said that the other end of the continuum is a point where prices do not reflest ANY information at all. Within the end of the continuum where prices reflect (or react to) some information set, weak form is at one end and strong form the other. I’d say that your statement about a strong-form efficient market being one where you can;t find an informational advantage (if I am understanding/paraphrrasing your statement correctly) is correct. But a market at the “other end” of the continuum would not necessarily one that’s easily manipulated. It would merely be one where prices do not reflect information (even info like price or volume trends) at all. It would also be once where prices do not REACT to new information in any consistent fashion (after all, if prices do not reflect available information, new info will not be impounded in prices).
That’s a good way of putting it.
Strong form wouldn’t have abrubt changes.