Behavioral Finance - a Challeng to Emh
1
1
Introduction
Finance is being said to be the domain of the perfect rationale. The rationality then creates an environment called “efficient markets”, where maximization of utility takes place and all actors act in this sense – earn more. The classical rationality argues that economical expectation derives the best forecasts as “price (at any time) fully reflect(s) available information on the market” (Fama, 1970), which is the core assumption in the EMH. However observing the day-to-day market behavior one would find that not all players act in this way and an observation of a longer period of asset price fluctuation makes one believe that there are rare people who act mathematically correct or rational with respect to classical utilitarian definition. A growing field of science, behavioral finance, attempts to explain and predict future irrational (or economically inefficient) behavior. Behavioral sciences are motivated by an argument that business finance, being conducted by people, can also include human irrationality aspects to be holistic. Nevertheless, literature adheres to the classical efficient markets theory and psychological effects are being ignored or seen as an extension to it. However, the ex-post analysis of asset prices shows that more data can be explained through application of behavioral science to modern finance. In course of this paper we are going to deliver an overview over the topic of behavioral finance to give a comprehensive explanation on what implications it makes regarding markets. Thus, in the second chapter we are going to introduce the concepts of efficient markets, anomalies on these markets and the respective paradigm shift. The third chapter given an overview over most common biases the human behavior is subject to. The fourth, conclusive chapter summarizes the paper. (written and edited: K. Klineskiy)
2
EMH & Behavioral Finance: A Paradigm Shift
Today’s literature on finance compromises
1
Introduction
Finance is being said to be the domain of the perfect rationale. The rationality then creates an environment called “efficient markets”, where maximization of utility takes place and all actors act in this sense – earn more. The classical rationality argues that economical expectation derives the best forecasts as “price (at any time) fully reflect(s) available information on the market” (Fama, 1970), which is the core assumption in the EMH. However observing the day-to-day market behavior one would find that not all players act in this way and an observation of a longer period of asset price fluctuation makes one believe that there are rare people who act mathematically correct or rational with respect to classical utilitarian definition. A growing field of science, behavioral finance, attempts to explain and predict future irrational (or economically inefficient) behavior. Behavioral sciences are motivated by an argument that business finance, being conducted by people, can also include human irrationality aspects to be holistic. Nevertheless, literature adheres to the classical efficient markets theory and psychological effects are being ignored or seen as an extension to it. However, the ex-post analysis of asset prices shows that more data can be explained through application of behavioral science to modern finance. In course of this paper we are going to deliver an overview over the topic of behavioral finance to give a comprehensive explanation on what implications it makes regarding markets. Thus, in the second chapter we are going to introduce the concepts of efficient markets, anomalies on these markets and the respective paradigm shift. The third chapter given an overview over most common biases the human behavior is subject to. The fourth, conclusive chapter summarizes the paper. (written and edited: K. Klineskiy)
2
EMH & Behavioral Finance: A Paradigm Shift
Today’s literature on finance compromises