Abstract
The paper provides a theoretical study on efficient market hypothesis (EMH) changes under the influence of behavioral finance. Authors of the paper briefly provide the basic assumptions of efficient markets theory and remind how the top of its dominance was reached in the 1970s. At the same time the goal of the paper is to develop the unbiased and complex overview of the today’s market efficiency and show its transformations under the impact of market participants’ irrationality. In the paper authors introduce the interaction between market efficiency, market arbitrage, irrationality of market participants and highlight the importance to revise the reliability of efficient market theory assumptions in order to achieve high performance of investment portfolios. Through the behavioral finance point of view authors not only aggregate the critics EMH faces during the recent years, but also evaluate today’s opportunities for arbitrage and provide arbitrage critics. According to documented by experimental economists departures from market efficiency and taking into consideration their nature, i.e. investors’ irrationality as a result of influence of a set of specific behavioral (both cognitive and emotional) biases, an alternative to EMH approach called “The Adaptive Markets Hypothesis” espoused by Andrew Lo in 2004 is introduced. The supporters of the EMH have responded to these challenges by arguing that, while behavioral biases and corresponding inefficiencies do exist from time to time, there is a limit to their prevalence and impact because of opposing forces dedicated to exploiting such opportunities. Finally, basic financial market anomalies are presented in the paper as an example of market inefficiency. On the one hand, their persistence in the face of public scrutiny seems to be a clear violation of the EMH. On the other - most of these anomalies can be exploited by relatively simple trading strategies, and, while the resulting profits may not be riskless, they seem usually profitable relative to their risks. Summing up of the investigation presented in the paper, authors conclude that many classical EMH supporters set the cases theoretically without empirical or real measurement analysis. Therefore the discussion on EMH is still on-going, but real market analysis should be done instead of evolving EMH theoretical evaluation models, which remain theoretical and do not always work properly in the conditions of real financial market. DOI: 10.5901/mjss.2014.v5n13p327
Highlights
The efficient market hypothesis is one of the most important paradigms in modern finance and was largely accepted to hold by the early 1970s
The behavioral finance came with the emergence of the critics about the three hypotheses about the efficiency of the market
All the transactions and the decisions of the investors are still made with the neoclassical financial rules in the mind, but as we saw we may wonder how it will become in the decade because the behavioral finance is winning importance every day
Summary
The efficient market hypothesis is one of the most important paradigms in modern finance and was largely accepted to hold by the early 1970s. It is known that changes in information make prices fluctuate and it would be possible for an investor to “make killing” if a released information causes a huge increase in price of security investor owns In this case EMH claims that one should not be expected to outperform market predictably or consistently. Theory would be denied and threatened if you could identify who those successful investors would be prior to their performance, rather than after the fact Another argument against EMH was for its statement that financial analysis is pointless and investors should not wais their time for price research. The competition among investors by seeking and analyzing the newest information in the market is the goal to take advantage of miss-priced stocks This is essential for the existence of efficient capital markets. The criticism is incorrect, because market efficiency can be achieved even if only a small group of informed and skilled investors trade in the market, while the rest of the investors never follow the securities which they trade
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