Essay on Efficient Market Hypothesis V's Behavioural Finance

1766 Words Feb 21st, 2012 8 Pages
Efficient Market Hypothesis v’s Behavioural Finance

An efficient market is one in which share prices quickly and fully reflect all available information, where investors are rational, and there are no frictions. Investors determine stock prices on the basis of expected cash flows to be received from a stock and the risk involved. Rational investors should use all the information they have available or can reasonably obtain, including both known information and beliefs about the future. In an efficient market there is “no free lunch”: no investment strategy can earn excess risk-adjusted average returns, or average returns greater than are warranted for its risk (Barberis, 2003). Market efficiency is assessed by determining how well
…show more content…
Due to the ease with which ratios for individual companies can be obtained and the return difference being so large, this may constitute strong evidence against market efficiency. However, a number of papers suggest that the unusual returns are due to biases in commercial databases, and to differences in risk, not to a true inefficiency. Thus further research is needed before any conclusion can be warranted but does leave speculation over market efficiency.
Another anomaly of EMH is the winner – loser problem. In two controversial papers, De Bondt and Thaler (1985 and 1987) have argued that investors tend to overreact to moving share prices. They find that stocks that have fallen most in price during the previous three to five years will tend to yield excess returns over the following three to five years. Whilst stocks that have been the best performers in the preceding three to five years will underperform in the subsequent three to five years. These results suggest that some useful past price information may be around that could be used to yield potential excess profit opportunities thus once again challenging the basis of market efficiency.
Conservatism is the principle that individuals adjust their beliefs too slowly to new

Related Documents