Fama: “The market price at any time instant reflects
all available information in the market”. Cannot “make money” using “stale information”. Three forms Weak form: past prices and returns. Semi-strong form: all public information. Strong form: all public AND private information. Michael Jensen: “there is no other proposition in economics which has more empirical support than the EMH”. Expected Utility Theory • A theory of choice under uncertainty for a single decision-maker. • Expected Utility = p1*u1 + p2*u2 + … + pn*un. p: probability of an event u: utility derived from the event Rational Expectations Paradigm • All investors are identical. • All investors are utility maximizers. • All investors use “Bayes rule” to form new beliefs as new information becomes available. • All investor predictions are accurate. Expected Utility + Rational Expectations => Market Efficiency Lessons from day one • What is behavioral finance and its effect on price “e” • How basic assumptions of mainstream economics fails. Bayes theorem failed. “Remember Doors”. • Impact of Behaviour “Ambiguity effect.