Behavioral Finance

Conclusion

And the Winner Is?

So who is right? Is the market efficient or mostly efficient? Or is it time for a new paradigm entirely that meets the criticisms that have been leveled by the behavioralists? There can be little question that over the past three decades the behavioralists have gained considerable ground and that even the most ardent defenders of the EMH have retreated a bit. Malkiel has kind words for mean-reversion in the latest editions of his classic,1 and even Fama is willing to admit that there are many open issues. Kahneman urges that the received finance theory not be abandoned, as it holds many truths.2 Shleifer has, at times, taken the middle ground, even though much of his research has done the efficient market hypothesis (EMH) the most damage.

This is a complicated debate, and the debate is far from over. There remain many different points of dispute. On some issues, the behavioralists seem to have taken the lead, but in other areas, the EMH still seems to reign supreme. In this chapter, we consider various points of contention and try to assess the current scorecard between the EMH and its critics.

THE SEMI-STRONG HYPOTHESIS—PRICES ACCURATELY SUMMARIZE ALL KNOWN PUBLIC INFORMATION

It is commonly accepted that the weak hypothesis (that prices cannot be predicted from past price data) is true. We will probably never have any idea whether the strong hypothesis (that prices accurately summarize all information, public and private) is valid, since traders ...