Coroporate Finance
Efficiency of Stock Market
According to Andrei Shleifer, Efficient Market Hypothesis (EMH) does not require that every investor be fully rational, however, investor required to have rational expectations. Efficient market hypothesis has the following implications for investor:
Rationality
It assumes that investors act rationality. It means that everyone in the stock market will adjust their expectation on the stock price in a rational way after new information announced.
Independent Deviations from Rationality
EMH also assumes that some investors are independently deviate from rationality meaning they are over-optimistic or over-pessimistic on the stock price. It suggests that the market will still efficient even though most investors are irrational as the effect of the irrationally optimistic investors will be neutralize by the effect of irrationally pessimistic investors immediately.
Arbitrage
The last assumption is that investors will scramble for any arbitrage chance which means “buy low sell high”. When a piece of information is announced, all investors will adjust the expected stock price at the same level and immediately buy the “underpriced” stock or sell the “overpriced stock” to maximize their earnings. Although there are some irrational investors, the arbitrage mechanism helps driving out any mispricing caused by any irrational actions.
All of the implications required the investors' reactions be random and follow a normal distribution pattern so that the net effect on market prices cannot be reliably exploited to make an abnormal profit.
Behavioral Biases
Despite the demonstration in EMH, there are many analysts have started to look at other elements present in financial markets, including human behavior, which affect decision-making in investment.
Behavioral biases: Over-optimistic and over-confident According to James Montier’s article, there are two behavioral biases affecting investors, including over-optimistic and
According to Andrei Shleifer, Efficient Market Hypothesis (EMH) does not require that every investor be fully rational, however, investor required to have rational expectations. Efficient market hypothesis has the following implications for investor:
Rationality
It assumes that investors act rationality. It means that everyone in the stock market will adjust their expectation on the stock price in a rational way after new information announced.
Independent Deviations from Rationality
EMH also assumes that some investors are independently deviate from rationality meaning they are over-optimistic or over-pessimistic on the stock price. It suggests that the market will still efficient even though most investors are irrational as the effect of the irrationally optimistic investors will be neutralize by the effect of irrationally pessimistic investors immediately.
Arbitrage
The last assumption is that investors will scramble for any arbitrage chance which means “buy low sell high”. When a piece of information is announced, all investors will adjust the expected stock price at the same level and immediately buy the “underpriced” stock or sell the “overpriced stock” to maximize their earnings. Although there are some irrational investors, the arbitrage mechanism helps driving out any mispricing caused by any irrational actions.
All of the implications required the investors' reactions be random and follow a normal distribution pattern so that the net effect on market prices cannot be reliably exploited to make an abnormal profit.
Behavioral Biases
Despite the demonstration in EMH, there are many analysts have started to look at other elements present in financial markets, including human behavior, which affect decision-making in investment.
Behavioral biases: Over-optimistic and over-confident According to James Montier’s article, there are two behavioral biases affecting investors, including over-optimistic and