Study On Efficient Market Hypothesis Finance Essay - Free Essay Example

Efficient Market Hypothesis (EMH) is the theory behind efficient capital markets. An efficient capital market is one in which security prices reflect and rapidly adjust to all new information. The derivation of the EMH is mostly credited to the work of Fama. In 1965 the doctoral dissertation written by Fama was republished. In this Fama looks at the current literature on stock price behaviour and examines the distribution and dependence of stock price returns. He concluded that, it seems safe to say that this paper has presented strong and voluminous evidence in favour of the random walk hypothesis. Due to a better understanding of price formation in competitive markets, the random walk model was now seen as a set of observations that can be consistent with the efficient markets hypothesis. This switch began with observations published in a paper by Samuelson in 1965. Samuelson presented his proof in the general form, which helped in the understanding of the notion of a well-functioning market. His paper had the observation in competitive markets there is a buyer for every seller. If one could be sure that a price would rise, it would have already risen. Samuelson stated that arguments like this are used to deduce that competitive pri ces must display price changesthat perform a random walk with no predictable bias. Following on by the work done by Samuelson, as mentioned in the previous paragraph, a paper was published by Fama in 1970. This paper consisted of a comprehensive review of the theory and evidence of market efficiency. He defined an efficient market as one in which trading on available information fails to provide an abnormal profit. This paper was one of the firsts to distinguish between the three forms of market efficiency. The three forms of market efficiency are the weak form, semi-strong form and strong form. He concluded that the results are strongly in support of the weak form of market efficiency and that in short, the evidence in support of the efficient markets model is extensive, and (somewhat uniquely in economics) contradictory evidence is sparse. I will now summarise some papers that have been written on the criticism of the EMH. Although there has been a vast amount of literature published on the development and the support of the efficient market theory, there has also been various studies published criticising the EMH. This criticism comes about due to the fact that the EMH is difficult to test. A number of studies indicate anomalous behaviour, which appears to be inconsistent with market efficiency. Such anomalies include the small firm effect as talked about in a paper by Banz in 1981. Banz analysed monthly returns over the period 1931-75 on shares listed on the New York Stock Exchange. Over this interval, the fifty smallest stocks outperformed the fifty largest by an average of one percentage point per month, on a risk-adjusted basis. After the publication of this paper, many other authors published their own papers examining the subject of the small firm effect. A paper by Ball in 1978 points out that the evidence could equally indicate the shortcomings of the models of expected return. A paper by Fama in 1998 concludes that further study should not be done on developing behavioural based theories of stock markets that take into account the apparent anomalies, but that search for better asset pricing models should take president. There is also the area of behavioural finance that criticises EMH. I will look at this in more depth in the next section. Market Bubble While the EMH is generally regarded as the best theory that can describe the actions of market prices it is not perfect and sometimes events occur that contradict the EMH. One of these events is that of the bubble. A bubble is when a specific industrys market prices do really well, so well that prices seem to rise higher than the EMH dictates. Eventually, the bubble bursts and prices return to a price more in line with EMH. One famous bubble was that of the dot.com bubble. EMH does not explain why this bubble exists in the first place. This is one of the major criticisms of the EMH. Many academics have turned to the relatively new theory of behavioural financ e to explain the bubble. Behavioural Finance One area that has recently undermined the EMH is the work published looking at behavioural finance. As observed by Shleifer (2000) At the most general level, behavioural finance is the study of human fallibility in competitive markets. Behavioural finance incorporates elements of cognitive psychology into finance in an effort to better understand how individuals and entire markets respond to different circumstances. Behavioural finance is based on the principle that all investors are not rational. Some investors can be over-confident, while other less knowledgeable investors might be prone to herding effects. Shefrin (1999) was one such author to talk about behavioural finance. He is one author who argues that a few psychological phenomena pervade the entire landscape of finance. Harrington (2003) agrees with the notion that overconfidence can lead to irrational behaviour. She states that investors can become irrational and their ir rational behaviour affects their ability to profit from owning stocks and bonds. Of course, behavioural finance does have its draw backs. One of which is the fact that using instincts alone can result in a loss. This is due to human error. The person that is using their instincts in determining where to invest might not have the greatest financial knowledge in the first place. Also, this person might be having a bad day or be under a great deal of stress or be distracted in some other way. This could result in the wrong decision being made. Therefore, it is a good idea to use both behavioural finance on top of the traditional theories already in use today. This view is supported by an article by Malkiel (1989) who agrees with the notion that behavioural aspects have a great importance in stock market valuation. He argues that behavioural factors play an important role in stock valuation alongside traditional valuation theories. This is summed up by the following quote, market val uations rest on both logical and psychological factors. The theory of valuation depends on the projection of a long-term stream of dividends whose growth rate is extraordinarily difficult to estimate. Moreover, the appropriate risk premiums for common equities are changeable and far from obvious either to investors or economists. Thus, there is room for the hopes, fears, and favourite fashions of market participants to play a role in the valuation process. Another article from the Banker (2004) also supports the view that behavioural finance has a role to play alongside the traditional views. In this section I will look at literature that tries to see if behavioural finance can explain this bubble. Many authors have argued that bubbles can be caused by over enthusiasm. For example, the new communication technology of the 1990s was exaggerated (causing the dot.com bubble). By this I mean that the new innovation is by some corners, i.e. the media and governments, over triumphed. Th is can lead to irrational behaviour of investors. This can lead to investors becoming over confident in the technology or industry. Another factor of this over enthusiasm is that it could attract herding behaviour. The irrational investor will be more likely to invest in something that is being hyped up as they feel that others are doing the same thing. They will feel that if others are doing it then it must be a good idea for them to do it as well. A factor that will have led to the development of a bubble is that of speculation. One such author that observed the speculation effect on the dot.com boom was Giombetti (2000). Many informed investors would have probably over invested in a specific industry going against market theory. They will have done this on the hope that their investment will pay off. Even if their investment were initially at a loss they would have stayed with it. Authors of behavioural finance outline this behaviour. This behaviour of these investors would have distorted the market conditions for other investors. Also, the herding effect would have been greater due to this. These factors would have led to the stock prices of a certain industry being vastly over priced. This would, therefore, cause the bubble. This bubble that has been created will, in turn, attract other investors. These investors will invest as they feel they are missing out on a good thing. This is another example of herding. This meant that when the bubble burst stock prices would have fell rapidly, causing investors to lose vast sums of money. This would cause them to pull out of the industry, which, in turn, causes the companies themselves to collapse. If it were not for irrational investment then investors might have pulled out earlier, before the collapse. This might have even meant that the collapse would not have happened. Other authors talk about some of the factors that cause investors to become irrational. On such author are Johnsson, Lindblom and P latan (2002). In their masters dissertation they talk about the various factors of irrationality. One of these is the observation that investors will hang on to losing shares longer than market theory dictates. They say that this is because they are waiting for the performance of the share to change for the better. This is referred to as loss aversion. This is an example of a psychological factor that is effecting the investment decision. Back to: Essay Examples Another psychological factor that affects investors, causing irrational behaviour is that of the feeling of regret. Authors argue that past bad decisions cause investors to feel regret and this alters their behaviour in such a way as to become irrational. Another factor that causes irrational behaviour is that of when the investor uses mental shortcuts in investment decisions. These shortcuts usually make investors choose the right decision but occasionally cause the investor to make the wrong decision. Optical illusions are a good example of how shortcuts can cause mistakes. A paper on www.undicoveredmanagers.com is one such paper that covers this point. Of course there are many authors who do not believe in the theory of behavioural finance. These authors argue that traditional financial theory can still be used to explain current market conditions. One such author is the person credited with the idea of the efficient market hypothesis, Eugene Fama. Fama (1998) argues that anomalies can be explained by traditional market theory. He argues that, apparent overreaction of stock prices to information is about as common as under-reaction and he suggests that this finding is consistent with the market efficiency hypothesis that the anomalies are chance events Other authors have argued that behavioural finance is only a study of individual investor behaviour. They argue that this theory has not been proven on a market wide scale. The tradition theories of finance have been. References www.UndiscoveredManagers.com (1999) Introduction to Behavioral Finance Ball R. (1978) Anomalies in Relationships Between Securities Yields and Yield-Surrogates, Journal of Financial Economics, 6, pp. 103-26. Banz R. (1981) The Relationship Between Return and Market Value of Common Stocks, Journal of Financial Economics, 9, pp. 3-18. Fama E. F. (1965) The behaviour of stock market prices, Journal of Business 38 (1), 34-105. Fama E. F. (1970) Efficient capita l markets: a review of theory and empirical work, Journal of Finance 25 (2), 383-417. Fama, E. (1998a). Efficiency survives the attack of the anomalies, GSB Chicago Alumni Magazine, (Winter):14-16. Giombetti R. (2000) The Dot.com Bubble. www.EatTheState.org Vol 4, Issue 23 Harrington C. (2003) Head games: Helping quell investors irrational antics. Accounting Today, v17 i11 p5(2) Johnsson M., Lindblom H. Platan P. (2002) Behavioral Finance And the Change of Investor Behavior during and After the Speculative Bubble At the End of the 1990s Malkiel B. G. (1989) Is the stock market efficient? Science, v243 n4896 p1313(6) Samuelson P. (1965) Proof That Properly Anticipated Prices Fluctuate Randomly. Industrial Management Review, 6, pp. 41-49. Scholes M. (1972) The Market for Securities: Substitution Versus Price Pressureand the Effects of Information on Share Prices. Journal of Business, 45, pp. 179-211. Shefrin H. Beyond Greed and Fear. (1999) Understanding B ehavioral Finance and the Psychology of Investing. Harvard Business School Press Shleifer A. (2000) Inefficient Markets. An introduction to behavioural finance. Oxford university Press The Banker (2004) Cover feature: how much risk can you manage? Banks have a huge range of resources available to aid risk managers, but human nature can still result in a bad decision. Behavioural finance and prospect theory lifts the veil on poor investment judgement

Wheres The Motivation - Literature Essay Samples

Often instead of the gallant, chivalrous hero, it is the deceptive, wicked villain that leaves a lasting imprint on the audience. The subversive and incorrigibly horrendous actions of the villains in Shakespeare’s Othello and Titus Andronicus, especially when compared to the helpless protagonists, demonstrate how a character can leave a deep impression on the reader and audience member. Iago and Aaron the Moor, although distinct in their fashion of wreaking havoc on the lives of their victims, do share one horrifying quality that ensures their literary reputation as true agents of evil; they lack motive. Although Iago claims that his hatred of Othello stems from the alleged adultery in which his commander and wife engaged, this reason is never substantiated nor expounded upon. As Iago creates his traps, it becomes clearer to the reader that he is a man intent on destroying Othello simply because he wants to. Just like Iago, Aaron is devoid of a clear motive for why he see ks to annihilate Lavinia and her father, Titus. He fervently plots to bring the Andronicus family to a horrible end, simply because he can. It is because these villains lack a motive and appear as malevolence incarnate that the audience is truly horrified and cannot, unlike the antagonists in other Shakespearean plays, downplay their actions and locate some tenable justification. At the conclusion of each play, the audience feels uneasy as to the fate of the villain. Though the persons of Iago and Aaron are sentenced to death, their introduction of pure wickedness into the world of the play’s characters seems to remain indefinitely. At the beginning of Titus Andronicus, Aaron seems to play an auxiliary role to his lover, the Queen of the Goths. He initially acts in the capacity of a quasi-jester – he puns and provides witty insight into the proceedings leading up to the â€Å"marriage† of Saturninus and Tamora. As the play progresses, however, his role as villain begins to surface with the rape and mutilation of Lavinia. In initiating what could be almost morbidly considered as clichà © villainy, Aaron, apparently consulting the villain’s playbook, Ovid’s Metamorphoses, suggests to Tamora’s lustful sons to rape Lavinia and cut off her tongue and both hands. The similarities between the actions of the characters in Ovid’s Metamorphoses and those of Tamora’s sons are shocking and serve to show that evil actions, even those as inconceivable as the ones perpetrated by Chiron and Demetrius, are always recurring. Aaron revels in his sin and, as he mentions many times throughout the play, regrets being revealed only because he cannot commit a thousand more horrors. In the third act of the play, Aaron tricks Titus into cutting off his own hand to save two of his sons. After Titus detaches his hand, the audience sees he was tricked. Titus is left with only one hand and the heads of his two sons. Aaron ’s following aside supports the lack of motive for his deceit and spiteful actions. He declares that, while good men will attempt to perform justly, â€Å"Aaron will have his soul black like his face† (3.1.204). The mention of a soul implicitly suggests that Aaron, in his capacity as an evil force, is immortal and though evil’s incarnation may eventually perish, evil itself will remain. The comparison between the darkness of his soul and his complexion not only hints at Shakespeare’s stereotype of Moors as essentially bad men, but it also connects the invisible and despicable qualities of Aaron with his perceivable physicality. As he indicates to the audience in his aside, the villain grows by perpetuating acts of painful trickery, stating â€Å"O, how this villainy/ Doth fat me with the very thoughts of it!† (3.1.201-2). As is indicated by the scoundrel himself, his soul and his face both darken merely by committing such acts; it seems as if he desires to do evil because, by doing so, he becomes ever increasingly the very embodiment of the vile. As Aaron’s â€Å"confession† in act five illustrates, he no longer is simply a man doing bad things and, by virtue of his inability to do good, he is marked as evil. As his language indicates, he is in fact incapable of doing anything but that which is considered horrendously dreadful. After enumerating the deeds of which he is most proud, in particular exhuming dead bodies and setting â€Å"them upright at their dear friends’ door,† he states that he has done all this â€Å"As willingly as one would kill a fly† (5.1.136,142). This passing analogy goes to say that just as a regular human being, if the bug were presented as a vex, would kill a fly without thinking, so does Aaron commit murder, rape, scandal and all other unmentionable horrors. The audience and reader’s reaction must be the shocking realization that this is truly no m an, for within the mind of a person there should exist a battle of good thoughts versus evil thoughts. For Aaron, and unfortunately for the Andronicus family, there is no such mental dichotomy; just as one could swat away a fly, Aaron as easily presents himself as absolutely wicked. In the same way that Aaron fails to cite any particular grievance that would fuel his plot of ruining Titus and his family, Iago commits his treachery without any discernable reasons. At the beginning of the play, Iago alleges that he has a â€Å"peculiar end† which drives his plan to destroy Othello for, as â€Å"it is thought abroad,† the Moor had â€Å"’twixt [Iago’s] sheets/ He has done [Iago’s] office† (1.1.60, 369-70). There is only one more mention of this allegation said in passing later in the play; since it is only rumor as Iago himself admits, the audience member and the reader cannot count on this proposed reason as particularly valid. In a state ment which echoes Aaron’s aside to the audience in Titus, Iago declares that his â€Å"outward action doth demonstrate/ The native act and figure of my heart† (1.1.61-2). Just as Aaron’s face will darken as his sins accrue, Iago’s appearance, as his â€Å"heart† begins to blacken, will relate to the other characters what he plans. In the second act of the play, Iago speaks to the audience after advising Cassio to plead with Desdamona in order to be reinstated as lieutenant. When Cassio exits and Iago is left alone, he begins by jesting â€Å"And what’s he then that says I play the villain,† when, he feels, he has provided Cassio with only the most truthful of advice and council (2.3.310). Superficially it appears as if this joke is meant to be an earnest entreat to the audience to find Iago to be, in fact, an honest person and the farthest thing from an evil man. But, keeping in mind his frightening preoccupation with torturing a ny and all of the other characters in the play, one can see that the joke is made tongue in cheek. Iago knows he is a villain, and since he has readily assumed the position of such, he can joke about his status as the antagonist. He partakes in a small confession in this scene, but the confession is not offered in hopes of reconciling his naughty ways; Iago is utterly proud of his treachery. Any other individual would perhaps still be proud that his or her plot had been successful thus far, but he or she would expectedly attempt to justify the reasons during his speech directed at the audience; Iago makes no attempt to do this. Iago refuses to try and rationalize his hatred because he doesn’t want to and, more importantly, he cannot; he has become the embodiment of unadulterated malice. The plays Othello and Titus Andronicus achieve their dramatic effect not through grandiose speeches or the noble and gallant actions of their protagonists. Quite oppositely, it is throug h that which remains unsaid that the audience is profoundly disturbed. The motivation that should logically drive the malicious actions of the villains remains undisclosed and, upon analysis of the language of Aaron and Iago, appears to be entirely nonexistent. Each antagonist thrives upon the accumulation of sin and, as Aaron explicitly states, his only regret is being unable to perform â€Å"a thousand more† (5.1.124). The ability and desire to do evil is the only motivating factor that drives the action of Iago and Aaron, and as they create more and more chaos within the lives of their victims, their despicable natures become physically visible on their persons. They eventually become a reflection of their minds; Aaron is as dark as his soul, and Iago, as the reader can imagine, can barely contain his glee at witnessing Othello’s demise.