Question

What does the efficient market hypothesis (EMH) say about securities prices, their reaction to new information, and investor opportunities to profit? What is the behavioral finance challenge to this hypothesis? Do you personally believe the EMH argument or the behaviorist argument?

Answer 1

The efficient market hypothesis believes that the stock prices reflect all the publicly available information and the stock prices quickly adjust to the release of the information as a result no investor van earn an above normal profit.

The basis of this theory is that the investors are rational human beings.In efficient market hypothesis theory, it is believed that is its futile to look for undervalued securities.No investor can earn an above normal profit without taking additional risks as all investors are privy to the same information .  As against this theory, the behavioral theory believes that human beings are not rational hence they are subjected to biases. They do not take decisions with a rational mind but their decisions are clouded by the various types of biases that affect them.Some popular biases are overconfidence, anchoring, hindsight bias. Now, when the investors decisions are affected by biases, the opportunities for mispricing exist and and this is an opportunity for the managers to use their skill and identify underpriced securities.

I personally believe in the behaviorist argument, as i gave personally been affected by loss aversion bias when i continued holding a losing stock in the belief that it will bounce back and thinking that i have not lost money until i do not realise this loss on y trading account.