An empirical evaluation of accounting income numbers • Ball, R., and P. Brown • Assignment
1 What do the authors accuse of accounting theorists doing to evaluate accounting practices? 2 How do the authors define net income as cited from other sources? 3 What theory is used by the authors to create a method to relate accounting income to stock prices? What is the method? 4. What do the authors claim determine a firm’s EPS
Explain this model. 5 Do you believe this model. Give some examples. 6 How do the authors model the behavior of individual firm stock prices?
Explain this model. 7 What are some econometric issues in correlating the residuals of the two models. 8 What fraction of variability in the changes in the median firm's income can be associated with changes in the market index? 9 When were earnings announced? Is there a trend in changes in announcement date?
11 Explain the chart in figure 1. 12 Is it unlikely that there is no relationship between the sign of the income forecast error and the sign of the rate of return residual in most of the months up to that of the annual report announcement? Why not? 13 Is most of the information contained in reported income is anticipated by the market before the annual report is released? Why? 14 What is variable (3) and why is it (the naive model) is clearly best for the portfolio made up of firms with negative forecast errors. 15. Your friend says “Cash is king and income is irrelevant”. How do you confront it? Another friend tells you to ignore nonrecurring items. How do you confront it? 16 Could the drifts in the indexes persist beyond the month of the report announcement.
Weak-form efficiencyExcess returns cannot be earned by using investment strategies based on historical share prices. Technical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysis may still provide excess returns. Share prices exhibit no serial dependencies, meaning that there are no "patterns" to asset prices. This implies that future price movements are determined entirely by unexpected information and therefore are random.
Semi-strong-form efficiencySemi-strong-form efficiency implies that share prices adjust to publicly available new information very rapidly and in an unbiased fashion, such that no excess returns can be earned by trading on that information. Semi-strong-form efficiency implies that neither fundamental analysis nor technical analysis techniques will be able to reliably produce excess returns. To test for semi-strong-form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner.
Strong-form efficiencyShare prices reflect all information, public and private, and no one can earn excess returns. If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. To test for strong-form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. Even if some money managers are consistently observed to beat the market, no refutation even of strong-form efficiency follows: with hundreds of thousands of fund managers worldwide, even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers
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10 What is API, the Abnormal Performance Index. Explain: