Behavioral and Rationalist Views of Markets, Efficient Market Hypothesis
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This article discusses the behavioral and rationalist views of markets, efficient market hypothesis, and offers a nuanced explanation of the efficient markets hypothesis.
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Running head: Economics1 Economics Institution Student Date
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Economics2 Economics How are the two views of markets, behavioral and rationalist, opposed? How are they compatible? Over the past years, the neoclassical view of human behavior in a market is now being progressively substituted by a different viewpoint normally called behavioral economics. Behavioral economics collects insights from numerous disciplines such as anthropology, neuroscience, economics, biology, psychology, and sociology to establish and forecast the way people in reality make their economic decisions. Instead of just citing some assumptions, behavioral economics put theoretical statements into tests by use of experiments and other practical verifications. Studies in this particular field have been confirmed important in explaining behaviors which might seem to be illogical, and why individuals normally appear to act against their own self-interest. Rational behavior, on the other hand, is the chief supposition of Rational Choice Theory (RCT). According to rationalist arguers, people often come up with sensible and rational decisions which offer them the uppermost amount of personal utility. Such decisions give individuals the maximum satisfaction or benefit– given the available choices– and are as well in their highest self-interest. However, whether people adopt behavioral or rationalists comportments, they all make decisions eyeing the most lucrative investments. They make decisions which will guarantee them splendid returns in their ventures (Shiller, 2013). What does Shiller mean when he says efficient-market theorists make a huge mistake: Just because markets are unpredictable doesn’t mean they are efficient? Explain. People’s brains are great at what they do since they come up with well-informed presumptions. That, however, leaves them prone to decision-making errors. Nowhere is this attribute more distinct than when people attempt to predict the future. Investors in a financial market make their
Economics3 predictions based on past experiences and as Sornette, (2017) says past performance at a given point in time is not a sign of future success. This implies that if people make wrong forecasts that does not translate or be a proof that the market is inefficient. It simply means their predictions were wrong or ineffective. Even the most experienced investing gurus make wrong predictions and therefore it is wrong to conclude that their forecasts failed due to market inefficiency.
Economics4 References Sornette, D. (2017).Why stock markets crash: critical events in complex financial systems(Vol. 49). Princeton University Press. Shiller, R. (2013).Speculative Asset Prices. Prize Lecture.
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Economics5 Can you offer a more nuanced explanation of the efficient markets hypothesis than either of the extreme views, that markets are absolutely efficient or that market participants are predictably irrational? Efficient Market Hypothesis (abbreviated as EMH) fundamentally points out that all freely available information concerning investment securities is readily put into consideration while pricing the securities. As a result, assuming this is factual; no amount of financial analysis can provide a speculator with a benefit over other investors, together called "the market." Efficient Market Hypothesis does not require investors to be rational. EMH rather requires that speculators shall act arbitrarily, but with uniformity, the market is at all times "right." In other words, "efficient" in financial markets means "normal." For instance, an extraordinary response to extraordinary information is normal. If a crowd of people abruptly starts running in a certain direction, it is normal for you to run towards that direction as well, though there are no any lucid reasons for doing that. There are different forms of Efficient Market Hypothesis, namely: Weak Form EMH, Semi-Strong Form EMH, and Strong Form EMH.