Thierry Martin
09-26-2006, 01:01 AM
Mad Money ... Mad Market?
September 25, 2006 | By Albert Phung
The efficient market hypothesis (EMH) has been a highly controversial topic among financial academics for decades, and CNBC's Jim Cramer is adding fuel to the fire. Volumes of journal articles, studies and other types of scholarly works have been churned out by supporters and critics of this hypothesis and the topic continues to be debated. Read on to find out how Cramer's in-your-face stock recommendations on CNBC's "Mad Money" provide evidence that the market behaves inefficiently.
Implications of EMH
The efficient market hypothesis contends that all equities are priced in a manner that reflects all relevant information about the stocks and/or the market. One implication of EMH suggests that because market prices should instantly reflect information as it occurs, performing research through fundamental analysis should not yield any new information that can allow an investor to make market-beating investment decisions. (For more insight, read Working Through The Efficient Market Hypothesis and What Is Market Efficiency?)
According to EMH, market efficiency also causes prices to be unpredictable and, therefore, technical analysis should not be able to yield indicators and chart patterns that serve predictive purposes.
Keep in mind that these implications are based only on EMH theory; there is much debate about the extent to which markets are efficient - or whether they are efficient at all. For example, counter to EMH, there are examples of investment strategies where fundamental analysis has proven to be successful. In fact, the "Oracle of Omaha", Warren Buffett, has earned consistantly market-beating returns for several decades by using fundamental analysis to pinpoint underpriced companies. (For more on this, see Warren Buffett: How He Does It, What Is Warren Buffett's Investing Style? and Introduction To Fundamental Analysis.)
The Study
Researchers from Northwestern University's Kellogg School of Management released a study called "Is the Market Mad? Evidence from 'Mad Money' " in March of 2006, which showed how Jim Cramer's recommendations on "Mad Money" have created a predictable trend, which some investors have used to make fairly high returns in a relatively short time frame.
For those who aren't familiar with "Mad Money", the show's host, Jim Cramer is a former hedge fund manager. On "Mad Money", Jim Cramer gives his buy/sell recommendation on a number of featured stocks, including stocks suggested by viewers' phone calls or emails. The show has become very popular - its entertaining nature about financial matters attracted more than 300,000 viewers nightly in 2006.
In this study, researchers had gathered stock returns, daily volume data, intraday quotes and other kinds of financial information on buy recommendations that Cramer made between July 28 and October 14, 2005. One of their key findings provides proof of the existence of the "Cramer bounce". According to the study, Cramer's buy recommendation causes a statistically significant short-term rise in the stock's price on the day directly following the day it is recommended. This rise is most apparent for small stocks, where the increase is just over 5% compared to the previous close. For the entire sample, the average rise is almost 2%.
Does this study suggest that Cramer has a knack for finding undervalued stocks at the right time? No. Instead, the researchers in this study theorize that stocks become overpriced because a large number of "Mad Money" viewers blindly buy stocks based on Cramer's recommendation. In other words, these rises were not attributed to any new news that companies had released and, most importantly, they were not sustained for very long. In fact, the study demonstrated that these increases faded away within 12 days. The inflation in stock prices that occurs as a result of Cramer's recommendations allows clever investors to obtain higher returns and, therefore, serves as evidence against the efficiency of the market,
The study also found that trading volume on the stocks that Cramer recommended also spiked dramatically. For smaller stocks, the trading volume increased by as much as 900% on the day following the recommendation. The most interesting effect is that, in some cases, the level of turnover stayed significantly elevated for as long as 16 days after the recommendation was made. It also appears that Cramer's recommended stocks generally receive much higher buyer-initiated trades on the day following a recommendation to buy. This may reflect a flood of purchase orders from regular "Mad Money" viewers. This peak in the proportion of buyer-initiated trades ultimately drops back to pre-recommendation levels after about 12 days. This suggests that Cramer's recommendations have a direct effect on stocks' prices - a notion that goes against EMH's assertion that stock prices reflect all relevant information and can't become inflated.
full article here:
http://www.investopedia.com/articles/06/madmoney.asp
September 25, 2006 | By Albert Phung
The efficient market hypothesis (EMH) has been a highly controversial topic among financial academics for decades, and CNBC's Jim Cramer is adding fuel to the fire. Volumes of journal articles, studies and other types of scholarly works have been churned out by supporters and critics of this hypothesis and the topic continues to be debated. Read on to find out how Cramer's in-your-face stock recommendations on CNBC's "Mad Money" provide evidence that the market behaves inefficiently.
Implications of EMH
The efficient market hypothesis contends that all equities are priced in a manner that reflects all relevant information about the stocks and/or the market. One implication of EMH suggests that because market prices should instantly reflect information as it occurs, performing research through fundamental analysis should not yield any new information that can allow an investor to make market-beating investment decisions. (For more insight, read Working Through The Efficient Market Hypothesis and What Is Market Efficiency?)
According to EMH, market efficiency also causes prices to be unpredictable and, therefore, technical analysis should not be able to yield indicators and chart patterns that serve predictive purposes.
Keep in mind that these implications are based only on EMH theory; there is much debate about the extent to which markets are efficient - or whether they are efficient at all. For example, counter to EMH, there are examples of investment strategies where fundamental analysis has proven to be successful. In fact, the "Oracle of Omaha", Warren Buffett, has earned consistantly market-beating returns for several decades by using fundamental analysis to pinpoint underpriced companies. (For more on this, see Warren Buffett: How He Does It, What Is Warren Buffett's Investing Style? and Introduction To Fundamental Analysis.)
The Study
Researchers from Northwestern University's Kellogg School of Management released a study called "Is the Market Mad? Evidence from 'Mad Money' " in March of 2006, which showed how Jim Cramer's recommendations on "Mad Money" have created a predictable trend, which some investors have used to make fairly high returns in a relatively short time frame.
For those who aren't familiar with "Mad Money", the show's host, Jim Cramer is a former hedge fund manager. On "Mad Money", Jim Cramer gives his buy/sell recommendation on a number of featured stocks, including stocks suggested by viewers' phone calls or emails. The show has become very popular - its entertaining nature about financial matters attracted more than 300,000 viewers nightly in 2006.
In this study, researchers had gathered stock returns, daily volume data, intraday quotes and other kinds of financial information on buy recommendations that Cramer made between July 28 and October 14, 2005. One of their key findings provides proof of the existence of the "Cramer bounce". According to the study, Cramer's buy recommendation causes a statistically significant short-term rise in the stock's price on the day directly following the day it is recommended. This rise is most apparent for small stocks, where the increase is just over 5% compared to the previous close. For the entire sample, the average rise is almost 2%.
Does this study suggest that Cramer has a knack for finding undervalued stocks at the right time? No. Instead, the researchers in this study theorize that stocks become overpriced because a large number of "Mad Money" viewers blindly buy stocks based on Cramer's recommendation. In other words, these rises were not attributed to any new news that companies had released and, most importantly, they were not sustained for very long. In fact, the study demonstrated that these increases faded away within 12 days. The inflation in stock prices that occurs as a result of Cramer's recommendations allows clever investors to obtain higher returns and, therefore, serves as evidence against the efficiency of the market,
The study also found that trading volume on the stocks that Cramer recommended also spiked dramatically. For smaller stocks, the trading volume increased by as much as 900% on the day following the recommendation. The most interesting effect is that, in some cases, the level of turnover stayed significantly elevated for as long as 16 days after the recommendation was made. It also appears that Cramer's recommended stocks generally receive much higher buyer-initiated trades on the day following a recommendation to buy. This may reflect a flood of purchase orders from regular "Mad Money" viewers. This peak in the proportion of buyer-initiated trades ultimately drops back to pre-recommendation levels after about 12 days. This suggests that Cramer's recommendations have a direct effect on stocks' prices - a notion that goes against EMH's assertion that stock prices reflect all relevant information and can't become inflated.
full article here:
http://www.investopedia.com/articles/06/madmoney.asp