Shrimad Rajchandra Institute of management and computer application

Subject- behavioral finance Assignment submission

Submitted to Dr. Prashant Joshi

Submitted by Mukesh Yadav (201104100710136)

ASSIGNMENT OF BEHAVIORAL FINANCE ON CHALLENGES TO THE EFFICIENT MARKET HYPOTHESIS ******************************************************************

"The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait."

The interesting assumptions surrounding the efficient markets hypothesis, maintains that, for all practical purposes, organized financial markets are efficient. The central issue surrounding market efficiency is simply the following: can an investor consistently "beat the market"? If the answer is "no," then the market is said to be efficient When comparing high-performing investments, for instance, we are less interested in absolute returns and more interested in excess returns. The excess return on an investment is the difference between the return earned on the investment, and the return earned on other investments with the same degree of risk. A positive excess return means that an investment has outperformed other investments of the same risk class. If you can consistently earn a positive excess return on your investment, then you are 'beating the market.' 3 forms of the emh have been identified,main characteristics are as follows:

weak-form efficiency the weak form of the emh states that all information contained in past share price movements is fully reflected in current market prices. The fact that a share has risen for the past few days would provide no useful clues as to what it will do today or tomorrow.

Semi-strong-form efficiency the semi-strong form of the emh states that current market prices reflect all publicly available information. Investors should therefore not expect to earn abnormal returns, unless they happen to have good luck, or are privy to information that is not publicly available another implication of semi-strong-form efficiency is that, when information is released to the public, share prices will only respond if the information is different from what had been expected. So, if a company announces a 20% increase in earnings, and that is pretty much what analysts had been expecting, then the announcement should have little or no effect on

the company's share price. On the other hand, if results are better than anticipated, the share price might well increase, while worse-than-anticipated earnings growth could see a fall in the share price.

Strong-form efficiency the strong form of the emh states that current market prices reflect all relevant information, whether publicly available or privately held. If the strong form of the emh were to apply, then even insiders would not be able to consistently earn abnormal returns in the stock market. The implications of market efficiency as a strong-form efficient market is not likely to exist outside the pages of a finance textbook, most attention has focused on weak form and semi-strong form efficiency. From an investor's point of view, the implications of both these forms of efficiency are dramatic. If a market is weak-form efficient, then the information contained in past share price and volume figures is of no value in beating the market. Share prices follow a 'random walk,' technical analysis (e.g. Charting) is of no use at all, and you might as well gaze into a crystal ball rather than at stock price charts to predict share price movements. In a semi-strong form efficient market, publicly available information of any kind is of no use in beating the market. Fundamental analysis (the analysis of company financial statements) also becomes useless, and you might as well cancel your subscriptions to financial magazines and newspapers as well! And before you reach for your recentlydiscarded charts, remember that historical share prices and trading volumes are publicly available information. If a market is semi-strong form efficient, it is also weak form efficient. You will not be surprised to hear that semi-strong form market efficiency is hotly disputed.

Challenges to market efficiency the following points have been raised, amongst others, to challenge the claims made by the efficient markets hypothesis:

Trading strategies based on historical price and volume data have been tested extensively, using computer programmes. Although the bulk of the evidence suggests that such strategies are unlikely to be successful, chartists point out that a computer programme is just the beginning. They claim that other subjective, non-quantifiable information and analysis are also needed, and that this subjective element is ignored by the computer programmes; The time perspective used in academic studies can be misleading. Long-term variations in share prices may be closer to a random walk (i.e. Unpredictable) than are short-term price movements;

The emh assumes that all investors process new information in the same way to make rational decisions. While some professional investors representing large financial institutions may resort to sophisticated methods of financial analysis, it is unlikely that all investors make decisions on this basis. It has been found that most investors, including professionals, have developed simplified techniques and rules (heuristics) which they apply when making investment decisions. Such heuristics are subjectively felt to be rational and may give satisfactory results, given the realities of the financial market; Following the above point, it is not unreasonable to assume that all information may not be used by all investors, or may not be used by all investors in the same way. In this case, there will always be investors making a profit on the basis of information. Markets will then be brought back towards efficiency through the trading of investors who exploit favorable price differences; It is hard to know whether all relevant information is, in fact, available to all market participants. As fischoff remarked in a 1982 book: "one of my favourite contrasts is that when the market rises following good economic news, it is said to be responding to the news; if it falls, that is explained by saying that the good news had already been discounted."

Conclusion:- 3 general comments regarding market efficiency 1) Short-term share price and market movements appear to be very difficult, if not impossible, to predict with any accuracy. 2) The market reacts quickly and sharply to new information, and most of the academic studies find little evidence that the market over-reacts or under-reacts to new information in a way that can be profitable exploited. 3) If the stock market can be beaten, the way to do it is at least not obvious, so the implication is that the market is not grossly inefficient.