The Emh, the Financial Crisis and the Behavioral Finance

It is believed that Efficient Market Theory is based upon some fallacies and it does not provide strong grounds of whatever that it proposes. More importantly the Efficient Market theory is perceived to be too subjective in its definition and details and because of this it is close to impossible to accommodate this theory into a meaningful and explicit financial model that can actually assist investors in making the investment decisions (Andresso-O’Callaghan, B., 2007).

As Chapter 10 questions, if further evidence continues to surface that capital markets do not always behave in accordance with the efficient market hypothesis, then should we reject the research that has embraced the EMH as a fundamental assumption? In this regard we can return to earlier chapters of this book in which we emphasised that theories are abstractions of reality. Capital markets are made of individuals and as such it would not (or perhaps, should not) be surprising to find that the

Financial Assets: Robert Shiller, a Noble Prize winner in Economics, has the belief that our cultural and psychological thoughts influence our financial behavior. Shiller highlights the key factors of the irrational exuberance that exists in the financial market. In his book, Irrational Exuberance, he argues that investors often make irrational decisions. Throughout the book, he explains that there are twelve factors that impact the market behavior from 1995 to 2005 and that eventually led to a financial bubble. Some of these factors can be linked to the Black Thursday of 1929.

In late October of 1929, the U.S. stock market crashed, setting our nation into the Great Depression. In an attempt to reveal the true catalysts of the event, the book “Causes of the 1929 Stock Market Crash” examines popular beliefs of what really caused the economic tragedy. The nine questionable causes that are discussed in this book are that the stock market was too high in September of 1929 due to “excessive speculation” (Bierman 32), there was a downturn in business activity, the Hatry affair, the Federal Reserve Board’s actions, a message that there was a “war” against speculators, excessive buying on margin and of investment stocks, excessive leverage in terms of debt, a competitively priced utility market segment paired with a setback in the public utility market, and an overreaction by the stock market.

This common outbreak of speculation caused about three main financial problems. First, this sudden stream of money going into the stock market caused the share prices to inflate, which caused the actual stock’s

It is often said that perception outweighs reality and that is often the view of the stock market. News that a certain stock may be on the rise can set off a buying spree, while a tip that one may be on decline might entice people to sell. The fact that no one really knows what is going to happen one way or the other is inconsequential. John Kenneth Galbraith uses the concept of speculation as a major theme in his book The Great Crash 1929. Galbraith’s portrayal of the market before the crash focuses largely on massive speculation of overvalued stocks which were inevitably going to topple and take the wealth of the shareholders down with it. After all, the prices could not continue to go up forever. Widespread speculation was no doubt a

The Efficient-Market Hypothesis (EMH) states that it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.

Further to the argument that agents were ignorant of and failed to engage with new information, the formation of asset price bubbles has been offered as a cause for the GFC. Ball argues that it is inherently difficult to recognise the presence of an asset price bubble until after the event has affected the market and even by recognising that prices did not accurately reflect true value, this could never have indicated a nearing price bubble burst to investors because EMH suggested that all then available information was

The research question in this essay is “To what extent have major events from 1980 – 2005 cause an economic bubble, in turn either appreciating or depreciating the American stock Market?”

The open market in the United States allows for many individuals and businesses to develop and grow their capital so long as financial regulation is handled properly. Proper regulation of loans allows for reasonable restriction towards speculation and encourages business expansion. When regulation is loosely held the economy suffers from misrepresentation of loans and broker ignorance. This can be represented through the New York Stock Exchange crash of 1929, which holds many similarities to the events leading to and after the United States subprime mortgage crisis. Increased popularity of on-margin loans almost directly correlate to the subprime mortgages that were made widely available in the first decade of the twenty first century. Brokers and loan originators, who fabricated on-margin and subprime mortgage loans, increased country-wide economic risk by encouraging individuals to accept monetary burdens they could not possibly afford. Also, as individuals continued to purchase on credit, a market economic bubble was formed. Once this bubble popped the Dow Jones, what individuals typically look to for market value, suffered a massive decrease in values. Each market crash displayed these occurrences, which can be correlated to one another.

Markets are places which people come together to trade stuffs, and stock market is an exchange where investors come together to buy and sell shares of publicly-treaded companies. (“The Financial Importance of the US Stock Market”) It’s good for our society in a great many ways, but it also can be harmful since people’s desire of money are fully exhibited in stock market. The Great Crash, happened in 1929, was not the event of one day but a series of events stretched initially across the week from October 23 through October 31. (Klein 326) This crisis had seriously impacted the U.S. by losing nearly 90 percent of the value of the stock market at that time. (Bierman) However, different from other events happened in the history, both government and normal people tended to blame the speculators at that time and avoid further investigations of it, but is the cause

According to the specialists, there are many reasons for this global financial crisis. We try to focus some prime reasons behind this

Efficient Market Hypothesis has been controversial issues among researcher for decades. Until now, there is no united conclusion whether capital markets are efficiency or not. In 1960s, Fama (1970) believed that market is very efficient despite there are some trivial contradicted tests. Until recently, both empirical and theatrical efficient market hypothesis was being disputed by behavior finance economist. They have found that investor have psychological biases and found evidences that some stocks outperform other stocks. Moreover, there are evidences prove that market are not efficient for instance financial crisis, stock market bubble, and some investor can earn abnormal return which happening regularly in stock markets all over the world. Therefore, the purpose of this essay is to demonstrate that Efficient Market Hypothesis in stock (capital) markets does not exist in the real world by proofing four outstanding unrealistic conditions that make market efficient: information is widely available and cost-free, investor are rational, independent and unbiased, There is no liquidity problem in stock market, and finally stock prices has no pattern.

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

However there are times when irrational investors are dominant. A possible cause of market overreaction is the tendency of some investors (often small investors) to follow the market. Such investors believe that recent stock price movements are indicators of future price movements. In other words they extrapolate price movements. They buy when prices have been rising and thereby tend to push prices to unrealistically high levels. They sell when prices have been falling and thereby drive prices to excessively low levels. There are times when such naive investors outweigh those that invest on the basis of fundamental analysis of the intrinsic value of the shares. Such irrational investors help to generate bubbles and crashes in stock markets.