What’s our Understanding of Market Efficiency? Flashcards
1
Q
Challenges efficient market hypothesis (3)
A
- fractal finance: misbehaviour of market (random)
- narrative economics: people go by popular stories to justify action
- behavioural finance
2
Q
Behavioural finance (4)
A
- reality of human behaviour
- investor are not fully rational
- can’t process information correctly without bias
- market not efficient
3
Q
Efficient market view (3)
A
- market price is right
- no profit opportunity
- fund manager don’t perform well
4
Q
Behaviour finance view (2)
A
- market price is not right
- no profit opportunity as arbitrage limits
5
Q
3 pillars of behavioural finance (3)
A
- error in investor information processing
- behaviour bias
- limit to arbitrage and thus error in price may not be correct
6
Q
Pillar 1 (6)
A
- forecasting error: memory bias
- sample size neglect: infer a pattern too quickly and extrapolate apparent trend too far into future
- overconfidence: tend to exaggerate skills
- conservatism: under react to news
- belief perseverance: hold on too tightly and for too long to news
- anchoring: do not adjust opinion sufficiently enough to new information
7
Q
Three type of bias (3)
A
- confirmation bias: support prior opinion
- self attribution bias: success and failure
- hindsight bias: prediction
8
Q
Pillar two (8)
A
- prospect theory: people attitude to risk when facing prospect of gain/loss
- loss aversion behaviour: more undesirable than equivalent gains (hold on to loss than gain)
- framing effect: way choices are framed can lead to different outcome (risk adverse to gain, risk seeking for loss)
- mental accounting: more risk averse, mentally segregate investment and have inconsistent risk trade off
- regret avoidance: more regret when it is wrong
- herding: group think
- escalation bias: more money into failure (decline justifiable)
- noise trader: non-professional with no special information
9
Q
Status quo utility function (3)
A
- change matter, not total wealth
- upside is conservative risk averse
- downside is risk loving
10
Q
Pillar three (3)
A
- fundamental risk: market goes other way
- implementation cost: short sell is powerful when overprice but entail cost
- model risk: basic assumption
11
Q
5 lesson learn from behaviour finance (5)
A
- avoid herding behaviour
- timing and selection penalties if too early/late
- avoid over trading (buy and hold forever)
- be wary of new issues
- fusion investment (sentiment + fundamental value)
12
Q
Adaptive market assumption (3)
A
- act in own interest
- makes mistake
- learn and adapt
13
Q
Adaptive market hypothesis (3)
A
- not efficient nor inefficient
- individual are both rational and emotional
- stable vs dynamic market
14
Q
EMH vs BF (2)
A
- EMH: rational, efficient, data
- BF: irrational, inefficient, people
