Classical Finance vs. Behavioral Finance
Prakant Sood, Raju Bhadrish
Efficient Market Hypothesis
Consider the example of a student and his professor who are walking down Wall Street. Thestudent spots a 100$ bill on the pavement and stoops down to pick it up. The professor thentells him not to waste his time for ³Had the bill actually been there, it would have beenpicked up´
That, in essence, is the concept of the ³Efficient Market Hypothesis.´ Whenever any newinformation arises, it spreads so rapidly that stock prices almost instantaneously reflect thechange. Thus, no study of stocks and careful stock selection should help over random stockselection. This is because all the effects of data being studied are already reflected in theinformation.
Also, at any time, stock price movements would be totally random, as is explained by theRandom Walk Theory. It stated that since stock prices reflect all current information, today¶sstock prices reflect fully today¶s information and tomorrow¶s prices would fully reflecttomorrow¶s information. Then the only new factor in determining the stock price movementsis the new information of tomorrow i.e. tomorrow¶s news, which is completely random, thusimplying that the stock price movements are also totally random.
types of Efficient Market Hypothesis:
In this type of a market, all past data and prices are reflected in the currentprices. Thus, Technical Analysis is not of any use.
In this type of a market, all public information is reflected in thecurrent stock prices. Thus, here, even Fundamental Analysis is of no use.
In this type of market, all information is reflected in the current stockprices. Thus, not only is any kind of analysis useless, even insider information isuseless for predicting future stock market prices.
This type of analysis involves detailed study and analyzing thecurrent stock prices and trying to logically analyze company information and predict futurestock prices.
This type of analysis involves statistical correlation of previous stockprices to establish some kind of relation between stock price movements.
ome studies to prove the feasibility of
In this modern age, there is truckload of information at one¶sfingertips due to the extensive reach of the internet. Data mining techniques arethen used to sift through the information and gather relevant correlation betweendata/past stock prices and try and find out patterns.