Efficient Market Theory and Behavioural Finance

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The behaviour of markets and investors, the decision making in the market place and the dynamics of demand and supply in any given market cannot be determined with a hundred percent accuracy. However master minds in the past have designed various techniques and theories that help investors make a particular buying decision, or to make choices logically. These theories and techniques help today’s investors to peep into the future and make almost immaculate predictions regarding the future behaviour of the market and the ongoing trends. A lay man night view the decision making of an investor as being solely based upon speculation but in reality every move that an investor makes today in the market place is backed up by sound calculation and theories. Two of the most talked about and essential theories or concepts that are related to the market dynamics and that will be discussed at length in this assignment are Efficient Market Theory and Behavioural Finance.

Efficient Market Theory suggests that in every financial market the flow of information is very efficient and this is reflected in the price of the share at which it is being traded. As we know that the price of the share floating in a market is not only dependent upon the company name printed and the information about the company in the balance sheet and other financial statements available to the public (Baghestani, H., 2009). In fact government and political stability, inflation, interest rates, treasury bills and several more factors determine the price at which any particular share is sold or bought at. Information about all these factors is always available to every investor in the market, be it the buyer or the seller.

Moreover this information is available in an effi...

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...ormation regarding the dynamics of the market and if this holds true then a financial market can never collapse. However in real world we face event like that of the 2007 global financial crisis that decelerated the global economic progress a great deal and once prosperous economies like the US ended up finding themselves in a state of panic where the poverty rose above all the previous levels and unemployment hiked to intolerable levels. Furthermore, the interest rates in the United States fell to a dreadful 1% during this crisis leading to falling savings in its economy. Hence we can conclude that Efficient Market Theory presents a weak argument to define market place dynamics. However if a combination of Efficient Market Theory and Behavioural Finance is utilized to predict market place dynamics then this would be defined as an efficient and effective approach.

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