#economics #personal-finance

Investment EMH

The Stock Market is Efficient

  • Only a minority of actively managed mutual funds beat the S&P index Active management Liu.
  • Roughly half of "mutual funds" are actually "closet indexers" - essentially index funds that are technically "actively managed" to justify higher fees Active management.

International Financial Markets are Not Efficient

  • Equity home bias puzzle - Most investors hold small amounts of foreign equity despite having a comparative advantage doing so. That being said, this irrational bias has shrunk over time. Equity home bias puzzle
  • Feldstein–Horioka puzzle - assuming perfect capital mobility, there should be minimal correlation between the amount of savings by a country and the amount of investment in that country. In reality, however, there is significant correlation Feldstein–Horioka puzzle.

My Analysis

I looked at 100 stock's daily returns from 1984 to 2017 Marjanovic and modeled each daily price move as

Y_it = B_0 + B_i1 + B_i2 * X_t + B_i3 * Norm()

where Y_t is stock i's daily return, X_t is the normalized change in the overall stock index, B_0 is the average index return, and the three B_i parameters represent alpha, beta, and idiosyncratic risk, respectively.

Of the 100 stocks, 4 rejected the null-hypothesis that B_i1=0. I'd expect 5 to reject the null-hypothesis by chance alone, so this is to say that I found no statistical evidence that any stock reliably beats the market.

This is actually puzzling because 89 of the stocks rejected the null-hypothesis that B_i2=1, which means that many of these stocks did have different levels of risk. Moreover, B_i3 didn't correlate with B_i2, which means stocks with high systematic risk (beta) also tended to have high idiosyncratic risk.

This raises the question: why does anyone invest in high-beta stocks if there's no evidence they compensate their owners with higher returns or even lower idiosyncratic risk?

Wikipedia contributors. (2020, September 4). Active management. In Wikipedia, The Free Encyclopedia. Retrieved 15:44, September 29, 2020, from https://en.wikipedia.org/w/index.php?title=Active_management&oldid=976753427 Liu, B. Preston, H. (2018). SPIVA® Institutional Scorecard: How Much Do Fees Affect the Active versus Passive Debate? https://www.spglobal.com/spdji/en//documents/spiva/research-spiva-institutional-scorecard-how-much-do-fees-affect-the-active-versus-passive-debate-year-end-2018.pdf Wikipedia contributors. (2019, December 4). Equity home bias puzzle. In Wikipedia, The Free Encyclopedia. Retrieved 20:52, September 9, 2020, from https://en.wikipedia.org/w/index.php?title=Equity_home_bias_puzzle&oldid=929180771 Wikipedia contributors. (2020, July 9). Feldstein–Horioka puzzle. In Wikipedia, The Free Encyclopedia. Retrieved 20:52, September 9, 2020, from https://en.wikipedia.org/w/index.php?title=Feldstein%E2%80%93Horioka_puzzle&oldid=966830962 Marjanovic. B. (2017). Huge Stock Market Dataset. https://www.kaggle.com/borismarjanovic/price-volume-data-for-all-us-stocks-etfs