Topic 5 - Market Efficiency and Behavioural Finance
- Monash University
- Commerce 2240
- Topic 5 - Market Efficiency and Behavioural Finance
Last Modified: 2011-09-06
- security prices immediately and fully reflect all available relevant information
- the reaction to new information is instantaneous and unbiased
- A large number of independent, profit-maximising investors engaged in the analysis and valuation of securities.
- New information comes to the market in a random fashion; the investors adjust security prices rapidly to reflect this new information. Thus, independent and random price changes.
- All information to reflect the "true" current value of stock.
- Statistical Tests of Independence (S.T.I)
- Tests of Trading Rules (T.T.R)
- Determine appropriate objectives and identify and evaluate constraints.
- Monitoring and evaluating Capital Market Expectations.
- Set investment policies and implement through optimal asset allocation. Elimination of specific risk becomes extremely important in E.M.
- Monitoring (Investor's circumstances, Market conditions, Relative asset category %)
- Portfolio Adjustments
- Risk Tolerance
- Require Rate of Return
- Time horizon
- Taxes Considerations
- Form of Income Needs
- Legal and Regulatory Constraints
- Market Structure Forces (M.S.F)
- Behavioural Forces (B.F)
- Uncertainty means that extreme observations are found in distributions (Coin Toss)
- Difficult to distinguish skill from luck
- Rarely many observations to test under the same conditions (i.e. similar skills)
- Vested interests in maintaining inefficiency
- Aversion to loss realisation (Winners disclose, losers hide)
- Individuals appear to have an aversion to loss realisation
- Paper losses are somehow better than real losses
- Illusion of knowledge (Overconfidence: hubris)
- Attribution Theory (Skill versus luck)
- People make Rational Decisions
- People are unbiased in their predictions about the future
- illusion of control / Self-enhancement tendencies
- Insensitivity to predictive accuracy / misconceptions of chance processes
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