Essay on 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…
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