Abstract
The nature of investor’s rationality vs. irrationality debate drawn attention of thousands of academic papers, hundreds of conferences, roundtables discussion leading to two ends: the classical theorist i.e. the proponents of efficient market hypothesis (EMH) and the behaviorist. From Fisher’s (1906) Nature of Capital & Income to Ross (1977); investor’s rationality has been considered as the principal assumption in the development of theoretical finance. Unfortunately though, various studies have shown repeated form of investor’s irrationality and incompetence in their decision process. Even the very proponents of EMH, Fama (1965) has later on in 1993 advocated the lack of market efficiency! Indeed the story of black Monday in the USA to the global financial tsunami (2007-2012) has put the proponents of EMH into the cluelessness. While, the behaviorists argument that the financial markets can be best understood by studying the psychology is also subject to criticism that there will be no existence of standard models to study agent’s behavior in the market! Therefore, this study aims at finding out the true scenarios of investor’s behavior by working on 200 individual investors in Dhaka Stock Exchange (DSE). Investors’ response to different questions relating to fundamental assumption of “rationality’ or ‘presence of irrationality. The result shows a complete absence of the assumption of rationality or irrationality in number of critical issues. Therefore, the idea of EMH or mere psychologically driven behavioral finance should become less acknowledgeable in understanding the agents of financial market i.e. the investors. Rather a combination of these two may give more insight in understanding the investor’s behavior in the financial market.
Highlights
Much of the economic and financial theories are based on the notion that, market participants acts rationally and considers all available information in the decision-making process
From fundamental analysis point of view, a stock market shows a strong sign of being bullish for several reasons including growth forecast in gross domestic product (GDP), increase in corporate sales, shifts in the term structure of interest rate, increased forecast in earning per share, earning and dividend signaling, etc. (Frank et al, 2000)
The fundamental reason for that can be in the discovery of the answer to the question of why investors decision process has to align with efficient market hypothesis (EMH) models of investment i.e. APT, CAPM, and Markowitz model, etc. when its assumptions are not absolutely real? Again without assuming that human has a brain to think and act rationally is it psychology only to explain human behavior?
Summary
Much of the economic and financial theories are based on the notion that, market participants acts rationally and considers all available information in the decision-making process. When agents receive new information, they update their belief correctly, as described by Bayers’ law. When agents receive new information, they update their belief correctly, as described by Bayers’ law1 Given their belief, agents make choices that are normatively acceptable, which is consistent with Savage’s notion of Subjective Expected Utility (SEU). Pricing model of Ross (1976) assumes that financial markets and its participants as a whole demonstrate rational behaviour and make wealth-maximizing decisions advocating the efficient market hypothesis (EMH). EMH has been originally defined by Fama (1965) as
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