Efficient Market Hypothesis And Behavioural Finance

2529 words - 10 pages

Efficient Market HypothesisThe efficient market hypothesis (EMH) is a belief that financial asset markets are fully efficient and thus correctly reflect all information. It evolved in the wake of work by Kendall (1953). He found price seemed to follow random walks, so that future price changes could not be predicted on the basis of past prices. The importance of news for asset prices led to the idea of the EMH.DefinitionThe efficient markets hypothesis (EMH) holds that a stock market is efficient if the market price of a company's shares (or other financial securities, such as bonds), rapidly and correctly reflects all relevant information as it because available. (Lumby & Jones, 1999) In a truly efficient stock market, if all information turned out to be entirely reliable and complete, share prices could be relied upon to correctly reflect the true economic worth of the shares.For a market to be efficient, three assumptions are needed, as shown below.1. All information relevant to financial asset prices must be costlessly, widely and quickly available. In information is costly to secure, or is known only to some investors, or spreads slowly, then asset prices might not reflect all information.2. There must be no transactions costs in purchasing or selling financial assets. Otherwise, if news arrives that leads people to believe that some assets are more attractive, then their price may not rise to reflect this because the transactions costs involved in buying them could outweight the gains that might be made.3. Investors must act rationally on the information they have, for otherwise asset prices will not correctly reflect available information.(King,1999)Levels of market efficiencyBefore discussing why the concept of market efficiency is important for financial managers, some questions must be answered. If stock markets are so efficient:1. Why have markets, institutions and individuals not always responded to significant changes in information ranging from patterns of dividend distribution to major political events?2. How can investors earn excess returns from changing fundamentals, technical analysis or Quants analysis of either market trends (based on the CAPM), or individual factors such as inflation, interest rates, industrial performance and risk attitudes ?3. Conversely, if not a direct consequence, why do even professionally managed institutional portfolios periodically under-perform relative to the market as a whole?(Hill, 1998)To explain why, the EMH has been propounded in three levels of market efficiency:* Weak form efficiency* Semi-strong form efficiency* Strong form efficiencyWeak form efficiency is the lowest level of efficiency. It implies no more than that share prices fully reflect any information that may be obtained from studying and analysing past movements in the share price. It states that only knowledge of past share prices is fully absorbed into today's price. The next price change is random in relation to currently...

Find Another Essay On Efficient Market Hypothesis and Behavioural Finance

The Tests for Market Efficiency Essay

2337 words - 9 pages During the 20th century, academic financial economists extensively accepted the efficient market hypothesis. Almost everyone was alleged that stock markets and securities market are highly efficient in response to any new information in the market. It was argued that when information regarding factors influencing market arises, the information spread like wild fire in the market and the prices of stocks adjust accordingly without any delay. This

Can above-average returns be earned on observing stock market overreaction?

9651 words - 39 pages presented will be based around short-term stock price reversals and stock market efficiency. Section 1 sets the scene and places the EMH in context, detailing a brief history of efficient market theory and underpinning specific literature to stock market overreaction and equity price reversals. Section 2 examines the overreaction hypothesis and reviews the most significant research papers, arguments, and literature on the subject. Section 3 outlines

Are stock markets efficient?

1329 words - 5 pages 1.The market efficiency conceptThe efficient market hypothesis (EMH) is a theory developed in academia in the mid-1960s. It holds that all securities are priced rationally in the market, that is, that prices fully reflect all available information. Because all information is contained in stock prices it is impossible to beat the market over time without taking on excess risk.Competition between rational investors keeps prices about where they

Financial and Monetary Economics

2364 words - 9 pages impounded in stock prices. Hence the notion that stock prices reflect all available information is known as the efficient market hypothesis (EMH). It was Professor Eugene Fama who created the term EMH, in his paper ‘Efficient Capital Markets’ and claimed that in efficient markets prices reflect all available information. There are three versions of the EMH, and each of these versions has a different implication for


1531 words - 7 pages to never lose sight of my financial goals. The term “random walk” was popularized by Malkiel and argues that the future cannot be dictated on the basis of the past. Random walkers are those who believe that price adjustments are so quick that an incumbent buying at current prices can perform as well as professionals. In line with the efficient market hypothesis, it means that no one person can consistently beat the market. However, Malkiel

Predicting Stock Market Return

2028 words - 8 pages efficient stock market it has not been possible to predict stocks, due to the failure of stock market variables not being statistically considerable. Furthermore, some authors have agreed to equate the comparison of stock market efficiency with the non-predictability property. However, this debate has no satisfactory results and this has also not specified the achievement of understanding market functions. Obligations of the hypothesis of market

Behavioral Biases and VaR

1327 words - 5 pages financial managers concerns the importance of information disclosure. If financial managers and shareholders want the stock market to correctly value the company's shares, they must ensure that they communicate sufficient information to the market to allow it to do so. In an efficient stock market, information disclosure is a key requirement.ReferencesHersh Shefrin, (2006), Behavioral Corporate Finance, McGraw-Hill/IrwinCoval, J., & Shumway, T

Major strategic and operational issues which should be considered when entering into overseas markets

1465 words - 6 pages issues and challenges of setting up their business overseas.REASONS FOR INVESTING OVERSEASForeign investments are usually motivated by a wider and more complicated set of strategic, behavioural and economic considerations than the domestic investment decision.Reasons for overseas investment include need to expand due to saturation of domestic market, access to scarce resources, improved production efficiency, more cost efficient and political safety

From a financial point of view what are the major strategic and operational issues which should be considered when entering into overseas markets?

1373 words - 5 pages more complicated set of strategic, behavioural and economic considerations than the domestic investment decision.Reasons for overseas investment include need to expand due to saturation of domestic market, access to scarce resources, improved production efficiency, more cost efficient and political safety. New overseas markets help business minimise its exposure to changes in domestic market demands and overseas investment allows a firm to increase

Rationality of Financial Markets on Investment Variables

595 words - 3 pages     The rationality of financial markets has been one of the most hotly contested issues in the history of modern financial economics. Recent critics of the Efficient Markets Hypothesis argue that investors are generally irrational, exhibiting a number of predictable and financially ruinous biases such as overconfidence, overreaction, loss aversion, herding, psychological accounting, miscalibration of probabilities, and regret. The sources of

Efficient Markets and Noise Trading.

1758 words - 7 pages Efficient Markets Hypothesis, Journal of Finance, 32, 663-6823. Black, F (1986) Noise, Journal of Finance, 41 (3), 529-5344. Brealey, R and Myers, S (1996) Principles of Corporate Finance, 5th Edition, McGraw-Hill: New York5. De Long, J, Shleifer, A, Summers, L. and Waldmann, R (1986) Noise Trader Risk in Financial Markets, J. Bradford De Long's Working Papers, 124, University of California at Berkeley, Economics Department.6. Dimson, E and

Similar Essays

The Efficient Market Hypothesis Essay

1836 words - 7 pages rational … and this renders the EMH inappropriate at best and silly at worse.”(Ross, (2002)) In my perspective, I would like to have a comparison between Efficient Market Hypothesis and Behavioural Finance. Behavioral Finance encompasses research that drops the traditional assumptions of expected utility maximization with rational investors in efficient markets. The two building blocks of behavioral finance are cognitive psychology and the limits to

Efficient Market Hypothesis Essay

2741 words - 11 pages The quote shows a strong relation to the efficient market hypothesis (EMH), as it implies that the costs of capital are dependent from the amount of information given by the company. According to my opinion, agency theory is a good explanation for costs of capital. Agency theory defines contracts as under which one party – called principal – engages another party – called the agent – to perform service

How Does Behaviour Affect An Individual’s Ability At Making Investment Decisions?

6561 words - 26 pages most of the academics that look into the school of thought of behavioural finance are psychologists.If an investor is aware off all the biases and aspects around them that are affecting their judgement skills and decision making process then they can offset these biases so that they make a rational and non-emotive decision. As it states in the efficient market hypothesis all markets and investors are rational and make rational decisions. If the

Stock Market: Efficient Allocator Of Resources?

1735 words - 7 pages Finance. New York: McGraw-Hill, 2011. Anorld, Glen. Corporate Financial Management. Harlow: Pearson Education, 2008. Borges, Maria Rosa. "Efficient market hypothesis in European stock markets." The European Journal of Finance, 2010: 711–726. Brealey, Richerd. A, Stewart.C Myers, and Alan.J Marcus. Fundamentals of Corporate Finance. New York: McGraw-Hill, 2009. BUCKLEY, GILL NORTH AND ROSS P. "A FUNDAMENTAL RE-EXAMINATION OF EFFICIENCY IN