Neoclassical Economics: Behavioral Aspects Of Market Anomalies

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Behavioral Aspects of Market Anomalies Anomaly is defined as ‘something that deviates from what is standard, normal, or expected’ by Oxford dictionary (2016). George and Elton (2001) has defined market anomaly as a new or unexpected phenomenon in relation to any theory, model or hypothesis. The founder of behavioural finance, Tversky and Kahneman (1986), suggested that the market anomalies are the indicators of inefficient markets, which might either occur only once and disappear, or occur regularly. The school of Neoclassical Finance is currently the prevailing paradigm in the finance field. In neo-classical finance, the investors make statistical judgement based on Von Neumann–Morgenstern utility theorem and Bayesian techniques (Ackert and …show more content…
The ‘loyalists’ support Efficient Market Hypothesis (EMH) by pointing out the problem of data mining or market imperfections, the ‘revisionists’ support EMH with time-varying risk premiums, whereas the ‘heretics’ challenge EMH and believe that the market is irrational and the psychological factors could influence the pricing of securities, where the abnormal returns can be earned by using specific trading strategies. The rationalists and revisionists believe that the stock returns cannot be predicted and thus the superior performance of specific investment strategies, for example the momentum and contrarian trading, and value investing are not an anomaly. They suggest that the superior returns are a result by chance instead (Black 1993). Besides, they argue that the abnormal returns are the result of higher risk premium (Fama and French, 1996). For instance, the value stocks are risker than the growth stocks, and thus the higher risk from investing in value stocks has generated the superior profits. However, a significant abnormal return can still be found even after adjusting for risk (Chopra, Lakonishok and Ritter …show more content…
The behavioural models attempt to explain the market anomalies using the judgement biases of investors that lead to the occurrence of over-reaction and under-reaction effect. De Bondt and Thaler (1985) have provided the evidence that the investors are irrational, overreacting to recent news and underreacting to prior information, and this irrational behaviour has created value anomaly. Furthermore, arbitrage opportunities are limited and risky in behavioural finance (Ackert and Deaves 2010¬). Hence, the stock prices might not immediately converge to their fundamental values which could lead to mispricing, where the investors can make use of in order to earn superior returns using past information, which is as opposed to EMH. For example, follow momentum trading that buy stocks with a good performance and sell stocks with a bad performance over the last three to twelve months to earn excess returns (Jegadeesh and Titman

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