Answer To: You have been employed as a consultant to an actively managed equity fund. Your task is to write a...
Sarabjeet answered on Oct 01 2020
Running head: EMH and BF
EMH and BF
Efficient markets hypothesis and behavioral finance
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Introduction
The goal of equity funds is to maximize profits and avoid the deficit of investors or customers. In a volatile market environment, it's not easy to make the right decisions every time. Therefore, for equity fund researchers, it is necessary to understand how price changes in the market and what decisions should be considered to maximize the profits from the market. In addition, there are two practical theories: the efficient market hypothesis and the behavioral financial assumption (Ardalan, 2018).
EMH, which states that stock prices can reflect all available information in the market. According to this theory, market efficiency has three different levels: weak form efficiency, formal efficiency, semi-strength and strong form efficiency. In weak efficiencies, the market can reflect all past information; it means that technical analysis based on past price forecast prices cannot be used. In the semi-strong form efficiency, not only the past information but also all public information (Blau, 2018). This means that only internal information can be used to get unusual profits. However, internal information is difficult to access. In the powerful form information, it indicates that all information is included. Nothing can be used to get an abnormal return. Another hypothesis of the theory is that new information is unpredictable, which means that the impact of new information is unclear, and luck is the only possible reason for investors to make a profit (Borges, 2010).
In the case of behavioral meaning, it focuses on analyzing individual psychological features and how it affects the characteristics of investors such as investors, analysts and portfolio managers. Identifying portfolio discrepancy can be explained by various psychological features (Brown, 2010). One of the related theories is named as Behavioral Finance Hypotheses. It focuses on identifying and recognizing the importance of cognitive factors that affect the rational behavior of investors (Charles, Darné & Fouilloux, 2012).
Market efficiency describes the range of which all available information is accurate and quickly embedded in the price. If the market is completely effective, then the price should be randomly and therefore unpredictable. Apart from this, in spite of business strategy, investors cannot get unusual returns without transaction costs. However, due to market friction, it is not present in theoretically legitimate market reality, which leads to temporary wage between transaction value and effective value. If the academic concept of efficiency creates a map for physician’s perception then inability to represent an intermediary opportunity exploits merchants. Efficiency refers to that degree whose prices are similar to running randomly in different time horizons. In this sense, different types of efficiency measures have been developed to show the deviation of the transaction value from the effective price. Keeping in mind the previous research, we focus on the four commonly used metrics to assess the speed at which information is included in the price i.e. auto correction; Variation ratio; Delay coefficient; and pricing errors (Kim & Kim, 2013).
This essay will evaluate the standpoint of the two Nobel Laureates, Eugene Fama and Richard Thaler, on market efficiency and behavioral finance respectively. The implications of these views for the fund will be illustrated at the end of this essay as well.
Detailed Discussion of Market Efficiency
Market efficiency describes the extent to which available information is precisely and quickly embedded in the price. If the market is fully effective, the price should go randomly and therefore unpredictable. In addition, regardless of the trading strategy, investors can't get abnormal returns without transaction costs. However, due to market friction, this theoretically valid market does not exist in reality, which leads to a temporary wedge between a transaction price and the effective price (Kuo, Shi & Shen, 2012). If the academic concept of performance maps is from a practical perspective, disability is an arbitrage opportunity that takes advantage of traders. From a large number of experienced literary perspectives, we measure market efficiency in three ways: 1) Random Walking; 2) trade policy; 3) Transaction expenses. Efficiency refers to the degree to which prices are similar to random walks in different time horizons. In this sense, a variety of efficiency measures have been developed to reflect the deviation of the transaction price from the effective price. In keeping with previous research, we focus on four commonly used metrics to assess the speed at which information is included in the price, i.e. autocorrelation; variance ratio; delay coefficient; and pricing errors (Le, 2012).
Market efficiency refers to the extent to which market prices reflect all available relevant information. If the market is valid, then all information...