SUBJECT CM2 CORE READING
Contents
Accreditation
Introduction
References
Unit 1 Theories of financial market behaviour
Unit 2 Measures of investment risk
Unit 3 Introduction to stochastic investment returns
Unit 4
...
SUBJECT CM2 CORE READING
Contents
Accreditation
Introduction
References
Unit 1 Theories of financial market behaviour
Unit 2 Measures of investment risk
Unit 3 Introduction to stochastic investment returns
Unit 4 Asset valuations
Unit 5 Liability valuations
Unit 6 Option theorySUBJECT CM2 CORE READING
Accreditation
The Institute and Faculty of Actuaries would like to thank the numerous people who have helped in
the development of the material contained in this Core Reading.
Introduction
The Core Reading manual has been produced by the Institute and Faculty of Actuaries. The purpose
of the Core Reading is to ensure that tutors, students and examiners understand the requirements of
the syllabus for the qualification examinations for Fellowship of the Institute and Faculty of
Actuaries.
The examinations require students to demonstrate their understanding of the concepts given in the
syllabus and described in the Core Reading; this will be based on the legislation, professional
guidance etc. which are in force when the Core Reading is published, i.e. on 31 May in the year
preceding the examinations. Examiners will have this Core Reading manual when setting the papers.
In preparing for examinations students are advised to work through past examination questions and
may find additional tuition helpful. The manual will be updated each year to reflect changes in the
syllabus and current practice, and in the interest of clarity.CM2 References
CS1 Actuarial Statistics 1
CS2 Risk Modelling and Survival Analysis
SP5 Investment and Finance Principles
SP7 General Insurance: Reserving and Capital Modelling Principles
Formulae and Tables for Examinations
Johnson, T. (2017). Ethics in Quantitative Finance: A Pragmatic financial market theory.
Palgrave Macmillan.
Davies, M. (2006). Louis Bachelier’s Theory of Speculation: The Origins of Modern Finance.
Princeton University Press.Subject CM2 Theories of Financial Market Behaviour 2020
© Institute and Faculty of Actuaries Unit 1, Page 1
UNIT 1 — THEORIES OF FINANCIAL MARKET
BEHAVIOUR
Syllabus objectives
Rational expectations theory
1.1.1 Discuss the three forms of the Efficient Markets Hypothesis and their
consequences for investment management.
1.1.2 Describe briefly the evidence for or against each form of the Efficient
Markets Hypothesis.
1 Rational Expectations Theory
1.1 The three forms of the Efficient Markets Hypothesis
From the 1930s until the early 1960s, there was a widespread folklore about how to make
money on the stock market. The dominant theory, going back to Adam Smith in the
1700s, was that markets are essentially fickle, and that prices tend to oscillate around some
true or fundamental value. Starting with the seminal work by Benjamin Graham,
traditional investment analysis involved detailed scrutiny of company accounts, t
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