Généralités sur l'investissement (document en anglais)

1. What role should a portfolio manager play in an efficient market?

To begin, an efficient market is an investment theory that says it is impossible to "beat the market". In fact, the stock market efficiency does that existing share prices incorporate and reflect always all relevant information.

But even if all stocks are priced fairly, a rational investment policy requires:

- To eliminate firm-specific risk through diversification --> the selection of a well-diversified portfolio provides the systematic risk level that the investor wants.

- To consider taxes. It is reflected in security choice.

- To take into account the particular risk profile of the investor.

- To take into account the age of the investors because it leads to warrant different portfolio policies with regard to risk bearing: older investors who are essentially living off savings might choose to avoid long-term bonds but younger investors might be more inclined toward them.

In conclusion, there is a role for portfolio management even in an efficient market. Investors’ optimal positions will vary according to those factors above. The role of the portfolio manager in an efficient market is to tailor the portfolio to these needs. The definition of an efficient market is then not very good because the portfolio manager doesn't have to "beat the market".

2. What are the momentum effect and the reversal effect? If there exist a short-run momentum and long-run reversal patterns, what are the implications for successful investment strategies?

The momentum effect is the idea of the impact of the momentum in securities: their price is more likely to keep moving in the same direction than to change directions, in other words the idea that the good or bad recent performance of particular stocks continues over time.

The reversal effect is the idea by which stock prices react to relevant news and this leads to the overthrow of extreme investment performance.

After the definitions above, we can deduce that a short-run overreaction (which causes momentum in prices) may lead to long-term reversals (when the market recognizes its past error). Then to have successful investment strategies, investors need to adapt their portfolio to this pattern.

3. What are the points of the behavioral (finance) critique of the efficient market hypothesis?

Behavioral finance is a relatively new field that seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions.

For example:

- The Prospect Theory said that people value gains and losses differently: losses have more emotional impact than an equivalent amount of gains.

- Frame : Decisions seem to be affected by how choices are framed, what are the things and conditions that are surrounding them.

- The Mental Accounting refers to the tendency for people to separate their money into separate accounts based on a variety of subjective criteria, like the source of the money... According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors.

- The Regret Avoidance says people anticipate regrets if they make a wrong choice, and take this anticipation into consideration when making decisions. In investing, the fear of regret can make investors either risk averse or motivate them to take greater risks.

4. What is technical analysis? Identify reasons why technical analysis may be profitable?

Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not take into account the security's intrinsic value, but charts and other tools in order to identify patterns that can suggest future activity.

Market fundamentals can be perturbed by irrational or behavioral factors, the technical analyze allows to be more precise and just taking into account the statistics datas.

...