Behavioral Finance Concept V. Efficient Market Hypothesis: Essay

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Behavioral Finance Concept v. Efficient Market Hypothesis:

For more than a century, the concept of efficient markets has been the subject of numerous academic researches and huge debates. An efficient market is described as a market with a large number of balanced profit maximizers that are actively competing against each other to forecast the future market values for individual securities. The efficient market is also defined as a market where current information is nearly freely available and accessible to all participants. Generally, in an efficient market, competition will make complete effects of new information on essential values to be reflected instantly in real prices (Singh, 2010). The efficient market hypothesis has developed to become a significant cornerstone of contemporary financial theory even though the market seems to be more modern and characterized by increased inefficiencies. As a result, the standard finance for rational analysis framework has been placed in an awkward position that has contributed to the emergence of behavioral finance theory that shakes the authority of efficient market hypothesis.

Behavioral Finance Theory:

Behavioral finance theory is a concept that emerged in the 1980s because of the shift towards including more behavioral science into finance. This concept has attracted numerous support across several economists because of some key areas in which the reality appears to be increasingly at odds with the efficient market hypothesis (Chuvakhin, n.d.). The concept of behavioral finance is a relatively new field that is geared towards combining cognitive psychological theory with traditional economics and finance. This is mainly for the purpose of providing explanations for the reasons people make irrational financial decisions (Phung, 2010). Behavioral finance theory is a rival account of capital markets due to theoretical and empirical restrictions or exceptions in efficient market hypothesis (Cunningham, 2002, p. 772).

Efficient Market Hypothesis:

Efficient market hypothesis can be described as the underlying concept that price reflects its essential value.

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It's a conventional framework in which the price of a security is equal to its fundamental value, which is the discount sum of future returns. The introduction of this term and financial concept is usually attributed to Eugene Fama, a concept that was further tested through various approaches in the 1960s. According to the founder of the concept, investors tend to be usually rational as markets precisely imitate all publicly known information. Consequently, the securities will usually be effectively priced since no amount of evaluation can contribute to out-performance. However, this concept has attracted numerous debates and criticisms as it's considered as one of the most egregious errors in the history of economic concepts (Wallace, 2010).

Difference between Behavioral Finance Concept and Efficient Market Hypothesis:

In the past few years, there have been numerous different arguments on behavioral finance concept and efficient market hypothesis, especially on the appropriate financial concept. Since 1990, the proponents of each of the two financial theories and concepts have developed and established various models that suit their position (Konte, 2008). The arguments have been raised because of the controversy surrounding efficient market hypothesis, which is a traditional framework and financial concept. Due to the controversies, academic professionals and economists have been forced to re-consider their thoughts regarding the composition of an efficient market and the efficiency of stock markets (Stangle, 2005, p. 124).

Throughout history, efficient market hypothesis has evolved….....

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