1. Roll's critique of tests of the CAPM shows that if the index portfolio is ex post efficient, it is mathematically impossible for abnormal returns, as measured by the empirical market line, to be statistically different from zero. Yet the Ibbotson study on new issues the cross-section empirical market line and finds significant abnormal returns in the month of issue and none in the following months. Given Roll's critique, this should have been impossible. How can the empirical results be reconciled with the theory?
2. In a study on corporate disclosure by a special committee of the Securities and Exchange Commission, we find the following statement (177,D6):
The "efficient market hypothesis"- which asserts that the current price of a security reflect all publicly available information- even if valid, does not negate the necessity of a mandatory disclosure system. This theory is concerned with how the market reacts to disclosed information and is silent as to the optimum amount of information required or whether that optimum should be achieved on a mandatory or voluntary basis; market forces alone are insufficient to cause all material information to be disclosed.
Two questions that arise are:
a. What is the difference between efficient markets for securities and efficient markets for information?
b. What criteria define "material information"?
3. In your own words, what does the empirical evidence on block trading tell us about market efficiency?
4. Mr. A has received, over the last three months, a solicitation to purchase a service that claims to be able to forecast movements in the Dow Jones Industrial index. Normally, he does not believe in such things, but the service provides evidence of amazing accuracy. In each of the last three months, it was always right in predicting whether or not the index would move up more than 10 points, stay within a 10-point range or go down by more than 10 points. Would you advise him to purchase the service? Why or why not?