1. INTRODUCTION
The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to explain human investors’ behaviors.
2. MAIN BODY
A generation ago, it was generally believed that security markets were efficient in adjusting information about individual stocks and stock market as a whole (Malkiel, (2003)). However, we cannot deny the efficient market hypothesis has several paradoxes.
In the first place, a main theoretical cornerstone for the EMH to be a consequence of equilibrium in capital markets is that markets are always rational. This is against the realism. Even if the foregoing assumption turn out to be entirely possible, many recent studies have concluded that rationality is not always a realistic assumption as investors in many cases engage in irrational investment (Kahneman and Riepe, (1998)).
Second, the efficient market hypothesis cannot explain market anomalies. These market anomalies include the pricing/earnings effect, the size and January effect, the monthly effect, holiday effect and the weekend effect. These anomalies indicate either market ineffici...
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... Capital, Corporation Finance and the Theory of Investment", The American Economic Review, vol. 48, no. 3, pp. 261-297.
Eugene Fama coined the term, efficient market hypothesis (EMH) in the 1960s. There are three forms of the efficient market hypothesis: the weak, semi-strong and the strong form. The weak form of the EMH states that the past price and volume is indicated by current asset prices. The current market price of security is revealed by the information controlled by previous series of prices. "It is named weak form because the security prices are the most publicly and easily accessible pieces of information. It implies that no one should be able to outperform the market using something that "everybody else knows" (Han, 2008, ¶ 6).
Schwert, G.W. (2001). Anomalies and Market Efficiency. In: G. Constantinides et al. (Eds). Handbook of the Economics of Finance, Chapter 17. North Holland: Amsterdam.
In summary, investors on the whole are rational and contribute to an efficient market through prudent investment decisions. Each investor?s optimal portfolio will be different depending on the feasible set of portfolios available for investment as well as the indifference curve for that particular investor. Lastly, risk free borrowing and lending changes the efficient set and gives the investor more opportunities to either get a higher expected return with the same amount of risk or the same amount of return with less risk.
The idea of an efficient market is very natural. From observation, it doesn’t seem easy to make lots of money by buying low and selling high, just as many investors fail on the stock market as succeed. If certain ‘smart’ investors can find ways to make profits on the stock market by buying low and selling high, then, according to theory, they will drive asset prices to their true values; by buying under-priced assets they will drive up those prices, by selling over-priced assets they will drive down those prices. Also, if there were substantial mispricing of assets, the ‘smart’ investors should make ...
...e efficient. But some markets are more efficient than others. And in markets with substantial pockets of predictability, active investors can strive for outperformance. Peter Bernstein concludes that there is hope for active management: 'the efficient market is a state of nature dreamed up by theoreticians. Neat, elegant, even majestic, it has nothing to do with the real world of uncertainty in which you and I must make decisions every day we are alive.'
Fama propounded EMH, in 1965, stating that provided all available information is used, market prices will reflect reasonably accurate approximations of the inherent present value of securities; the employment of this information would render agents’ actions rational. Ball expands on this by suggesting that competitive markets lead to costs falling in line with the employment of information.
According to Perold (2004), ‘CAPM can be served as a benchmark for understanding the capital market phenomena that cause asset prices and investor behavior to deviate from the prescript...
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among numerous users. The roles of the stock market are mainly to facilitate and encourage the mobilization of funds, direct them towards efficient economic activities, provide adequate liquidity for investors and encourage the creation of large-scale enterprises, The Kuala Lumpur Stock Exchange Index (CI) is the most popular indicator of the Kuala Lumpur stock market performance. The CI represents share prices of 100 Corporations. These companies are chosen because their operations cover a broad spectrum of economic performance in Malaysia and more significantly reflect stock market activities with fair accuracy, Stock prices depend on the supply and demand for the stock, it causes by the factors that stock prices to be more volatile is limited supply of new issues despite of strong demand for the stocks. This restriction of supply leads to more price fluctuations, which are common to all stock markets. However, two things prevent an infinite price increase in the stock market. Firstly, the amount of money available in any country is finite. As the bull market proceeds, more and more of the country’s savings are invested in the stock market and eventually the people involved might face liquidity...
Dalton, John M. How the Stock Market Works. New York: New York Institution of Finance, 1993.
Fama, E. (1970). Efficient capital markets: A review of theory and empirical work. Journal of finance, Vol. 25, pp. 383-417.
There is a lot of research work going on in this particular field, more so since the crisis of 2008. The purpose of this article was to make readers aware of the subject .Behavioral finance is an interesting mix of logics, psychology and economics. Budding investors and management students should look into this in more detail so that they are better equipped to make financial decisions.
This paper will define and discuss five financial theories and how they impact business decisions made by financial managers. The theories will be the Modern Portfolio Theory, Tobin Separation Theorem, Equilibrium Theory, Arbitrage Pricing Theory (APT), and the Efficient Markets Hypothesis.
In the modern world, financial markets play a significant role, with huge volumes of everyday dealings. They form part of contemporary economic lifestyle and determine the level of success of many people. Humans have always been uncertain of what the future holds and thus, tried to forecast it. The forecast of course cannot omit the likelihood of “easy money” by forecasting the prices of equity markets in the future.