Efficient Market Hypothesis and Behaviourial Finances

Running head: FINANCE 1
Efficient Market Hypothesis and Behaviourial Finances
Student’s Name
Institution Affiliate
Date

FINANCE 2
Efficient Market Hypothesis
The efficient market hypothesis was widely accepted by the financial economist over the
past few decades ago. Such a wide acceptance was due to the fact that the stock prices were
typically reflected by the information that was provided by the securities market. The above idea
depends on the random walk theory which entails a price series in which there is often a change
in the price of stock randomly from the previous prices. According to this hypothesis, it prevents
the various investors from earning revenues which are above the average returns and this usually
occurs without agreeing to the above average risks (Degutis & Novickytė, 2014)
It, therefore, insists on an efficient financial market and this is in regards to the
communication, news, and information involved. An efficient financial market occurs when
there are numerous individual profit maximizers competing against each other and aims at
forecasting on the future market values of the securities.
Based on the work of Eugene Fama, he argued that the prices of the stock were a
reflection of the fundamentals of economics and that the prices changed randomly in the
financial markets.Fama, defined the efficient market hypothesis as a market which is competitive
and that the random feature of fluctuation is based on the price converges to the value which is
considered to be fundamental. He defended the Random walk because he considered it as a good
description of the fluctuations existing in the market for the stock and this is because the random
walk is a better estimation of the behavior of price. He also introduced the rationality concept
where he argued that an efficient market contains a huge number of rational profit maximizers
who are competing with the aim of forecasting the future market values.

FINANCE 3
Robert Shiller however opposed the efficient market theory and this was specifically on
the random walk theory. He argued that the response of the stock market to new information was
never predictable.
Behavioural Finance
The behavioral finance involves a study of the behavior of the investor market and this is
usually based on the psychological principles in the process of making certain decisions. Such
decisions usually involve those providing insights on the reasons as to why certain individuals
purchase and sell stock. The concept of behavioral finance has been associated with the
behavioral cognitive which focuses on studying the economics of financial market and decision
making by human beings (De Bondt, Muradoglu, Shefrin & Staikouras, 2015). The primary goal
of the above concept is to focus on the interpretation of the investors and also their actions
towards the making of certain informed decisions on investment. Richard Thaler in his work
identified certain anomalies and the first one was in regards to the closed end funds. He defined
closed funds as the money which raises the investor’s capital and then it is later allocated to
stock or any other asset. Additionally, he suggested for a behavioral framework to comprehend
the closed end fund prices and this is because some of the prices would change based on an
investor’s sentiments.
Further, there is a certain reason which makes the behavioural finance to be considered as
an irrational behavior by the investors and such may include, the representativeness which entails
various individuals seeking to fit in certain new events (De Bondt et al., 2015).
In the real world, the above concepts are applied by most of the investors when making
certain fundamental investment decisions (Rad, 2016). For example, the efficient market
hypothesis has been sued by the investors to prevail over a particular stock market and this