Market Efficiency

An important concept is the difference between Market Value and Intrinsic Value. Market Value is the asset's current market price; Intrinsic Value is the fair value determined by each investor, usually using proprietary models. When referring to current price, it's Market Value; fundamental value refers to Intrinsic Value. In an efficient market, they are equal.

Factors Affecting Efficiency

• Promote efficiency: Arbitrage, short selling
• Reduce efficiency: Transaction costs, information acquisition costs

Forms of Market Efficiency

• Weak form: Prices reflect past market data. Technical analysis does not generate Alpha.
• Semi-strong form: Prices reflect all public information. Passive management outperforms active management; Alpha only possible with private information.
• Strong form: Prices reflect all public and private (insider) information. Portfolio managers focus on asset allocation and diversification, not beating the market.

Market Pricing Anomalies

1. Time Series Anomalies

• Calendar effects: January Effect, Turn of the Year effect (stocks rise in January, especially small caps)
• Momentum anomalies: Overreaction effects—prices react to news
• Window Dressing: Funds sell risky assets before year-end
• Other effects: Day of the Week, Weekend, Turn of the Month, Holiday

2. Cross-Sectional Anomalies

• Size effect: Small-cap stocks outperform large-cap stocks risk-adjusted
• Value effect: Value stocks (low P/E, high dividends) outperform growth stocks
• Earnings surprise and IPO anomaly: Positive earnings surprise or IPO offering price leads to abnormal profits

3. Data Mining Anomalies

Statistical patterns from excessive data searching, can be spurious.

Behavioral Finance

• Risk aversion: Higher risk, higher expected return
• Loss aversion: Investors dislike losses more than gains; tend to hold losing positions and quickly realize profits
• Overconfidence: Excessive confidence in predictions (common among day traders)
• Herding & information cascade: GameStop example—information cascade leads to herding behavior

Cognitive Biases

• Representativeness: Making decisions based on limited information
• Mental accounting: Treating investments as separate 'boxes' (e.g., different risk levels for retirement vs. other investments)
• Conservatism: Slow to react to new, contradictory information
• Narrow framing: Focusing on isolated events when making decisions (e.g., avoiding U.S. investments after terrorist attacks)

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