Explaining the functioning of financial markets

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Market efficiency is an important concept in explaining the functioning of financial markets. Empirical researchers have conducted tests on market efficiency using a variety of methods, including serial correlation and portfolio studies.

a) Fama and French (1992, 1993) observed that two classes of stocks tended to outperform the overall market. Identify the classes of stocks Fama and French tested and briefly explain how these factors may be used to explain portfolio returns.

b) Outline how you would apply the portfolio study methodology used by Fama and French to test whether firms with faster sales growth are more likely to be over-valued.

c)Tests of serial correlation are often used to examine whether the market is weak-form efficient. Discuss what type of serial correlation you would expect to find in very short-term price changes.

Reference no: EM132548185

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