Efficient Market Hypothesis and Behavioral Finance

Efficient market hypothesis and Behavioral finance

Fall 2011 Teacher: Guðrún Johnsen V-780-BFIM

Student: Rúnar Guðnason SSN:1804784939

Table of Contents
Introduction ................................................................................................................................ 3 1.1 Efficient market hypothesis .................................................................................................. 3 1.2 A criticism on the efficient market hypothesis ................................................................. 4 2.1 Behavioral finance and the efficient market hypothesis ...................................................... 5 2.2 Prospect theory and Loss aversion ................................................................................... 6 2.3 Mental accounting ............................................................................................................ 8 2.4 Framing ............................................................................................................................. 9 2.5 Overconfidence ............................................................................................................... 10 2.6 Representativeness heuristic ........................................................................................... 11 2.7 Conservatism .................................................................................................................. 12 2.8 Feedback theory (herd behavior) .................................................................................... 12 2.9 Limits to arbitrage .......................................................................................................... 13 3.1 The defense for the efficient market hypothesis ................................................................ 14 4.1 Discussion .......................................................................................................................... 15 References

References: Barber, B. M. and Odean, T. (2001). Boys will be boys: Gender, overconfidence, and common stock investment. [electronic edition]. The Quarterly Journal of Economics, 116, 261292. Barberis, N. and Huang, M. (2001). [electronic edition]. Mental accounting, loss aversion, and individual stock returns. The Journal of Finance, 56, 1247–1292. Barberis, N. and Huang, M. (2005).The Loss Aversion / Narrow Framing Approach to the Equity Premium Puzzle. In Mehra, R. (ed.), Handbook of the Equity Risk Premium. (page. 201-228). Elsevier Science. Got 27. October 2011 of http://forum.johnson.cornell.edu/faculty/huang/review_on_EP.pdf Barberis, N. C. og Thaler, R. (2003). A SURVEY OF BEHAVIORAL FINANCE. In G. M. Constandinides, M. Harris and R. Stultz (ed.), Handbook of the Economics of Finance (page. 1052-1114). Elsevier. Got 27. October 2011 of http://www.google.is/search?q=Barberis+and+Thaler&ie=utf-8&oe=utf8&aq=t&rls=org.mozilla:is:official&client=firefox-a Barberis, N., Huang, M. and Thaler, R. H. (2006). Individual preferences, monetary gambles, and stock market participation: A case for narrow framing. [electronic edition]. The American Economic Review, 96, 1069-1090. Barberis, N., Huang, M., and Santos, T. (2001). Prospect theory and asset prices. [electronic edition]. Quarterly Journal Of Economics, 116, 1-53. Basu, S. (1977). Investment performance of common stocks in relation to their price earnings ratios: A test of the efficient market hypothesis. [electronic edition]. The Journal of Finance, 32, 663-682. Benartzi, S. and Thaler, R. H. (1995). Myopic loss aversion and the equity premium puzzle. [electronic edition]. Quarterly Journal Of Economics, 110, 73. Coval, J. D. and Shumway, T. (2005). [electronic edition]. Do behavioral biases affect prices? The Journal of Finance, 60, 1–34. 17 Durham, G. R., Hertzel, M. G. and Martin, J. S. (2005), The market impact of trends and sequences in performance: New evidence. [electronic edition]. The Journal of Finance, 60, 2551–2569. Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. [electronic version]. Journal of Finance, 25, 383-417. Fama, E. F. (1998). Market efficiency, long-term returns, and behavioral finance. [electronic edition]. Journal of Financial Economics, 49, 283-306. Fama, E. F., Fisher, L., Jensen, M. C. and Roll, R. (1969). The adjustment of stock prices to new information. [electronic edition]. International Economic Review, 10, 1-21. Fama. E. F. (1965). Random walks in stock market prices. [electronic edition]. Financial Analysts Journal, 21, 55-59. Froot , K. A. and Dabora, E. M. (1999). How are stock prices affected by the location of trade? [electronic edition]. Journal of Financial Economics, 53, 189-216. Gibbons, M. R. and Hess, P. (1981). Day of the week effects and asset returns. [electronic edition]. The Journal of Business, 54, 579-596. Grossman, S. J., and Stiglitz, J. E. (1980). [electronic edition]. On the impossibility of informationally efficient markets. American Economic Review, 70, 393-408. Kahneman, D. and Tversky, A. (1982). On the study of statistical intuitions. [electronic edition]. Cognition, 11, 123-141. Khaneman, D. and Tversky, A. (1979). Prospect theory: An analysis of decision under risk [electronic edition]. Econometrica, 47, 263-291. Khaneman, D. and Tversky, A. (1986). Rational choice and the framing of decisions. [electronic edition]. Journal of Business, 59, 251-278. Long, J. B. (1978). The market valuation of cash dividends: A case to consider. [electronic edition]. Journal of Financial Economics, 6, 235-264. Malkiel, B. G. (2003). The efficient market hypothesis and its critics. [electronic edition]. Journal Of Economic Perspectives, 17, 59-82. 18 Miller, M. H. and Modigliani, F. (1961). [electronic edition]. Dividend policy, growth, and the valuation of shares. The Journal of Business, 34, 411-433. Odean, T. (1998). Volume, volatility, price, and profit when all traders are above average. [electronic edition]. The Journal of Finance, 53, 18871934. Rozeff, M.S. and Kinney, W. R. (1976). Capital market seasonality: The case of stock returns. [electronic edition]. Journal of Financial Economics, 3, 379-402. Schwert, G. W. (2003). Anomalies and market efficiency. In G. M. Constandinides, M. Harris and R. Stultz (ed.), Handbook of the Economics of Finance (page. 939-974). Elsevier. Got 28. October, 2011 of http://www.sciencedirect.com/science/article/pii/S1574010203010240 Shiller, R. J. (1981). Do stock prices move too much to be justified by subsequent changes in dividends? [electronic edition]. American Economic Review, 71, 421. Shiller, R. J. (2003). From efficient markets theory to behavioral finance. Journal Of Economic Perspectives, 17, 83-104. Shiller, R. J. (2005). Irrational exuberance. New York: Broadway Books. Solt, M. E. and Statman, M. (1989). Good companies, bad stocks. [electronic edition]. The Journal of Portfolio Management, 15, 39-44. Thaler , R. H. (1999). The end of behavioral finance. [electronic edition]. Financial Analysts Journal, 55, 12-17. Thaler, R. (1985). Mental accounting and consumer choice. [electronic edition]. Marketing Science, 4, 199-214. Thaler, R. (1999). Mental accounting matters. [electronic edition]. Journal of Behavioral Decision Making, 12, 183 -206 . Tversky, A. and Kahneman, D. (1974). Judgment under Uncertainty: Heuristics and Biases. [electronic edition]. Science, 185, 1124-1131. Weber, M. and Camerer, C. F. (1998). The disposition effect in securities trading: an experimental analysis. [electronic edition]. Journal of Economic Behavior & Organization, 33, 167-184. 19 Weinstein, N. D. (1980). Unrealistic optimism about future life events [electronic edition]. Journal of Personality and Social Psychology, 39, 806-820. 20