The Market Efficiency Debate: Developments of Financial Market Theories

Abstract

A united hypothesis to explain the price movement of financial assets has been a significant research goal over the past few decades. This paper reviews the existing literature on both Efficient Markets and Behavioral Finance, concluding with more contemporary literature that attempts to combine the two theories. It summarizes the EMH and Behavioral Finance concepts, the debate between them, and the evidence supporting both. By recognizing the vast swaths of evidence in support of both hypotehses, one can conclude that the questions surrounding the efficiency or inefficiency of markets remain unanswered. Instead, the evidence supporting both hypotheses suggests the necessity of a compromise to rationalize these results instead of relying on one hypothesis or another. The compromise between both hypotheses, in turn, makes the debate between efficiency and inefficiency almost moot. Researchers must account for human misbehavior and rational expectations on a spectrum when formulating new market hypotheses, remaining open to changes in market theory as new variables continue to be discovered.