Behavioral Finance Economics 437

Review of EMH Four Different Articles addressing what EMH means and the history of Behavioral Finance Shleifer (Chapter 1) Schiller (on Collab at course website) Malkiel (on Collab at course website) Fama (on Collab at course website)

Reading (starting Jan 25) “Noise Trading” – Limits to Arbitrage Black on Toolkit Shliefer on Toolkit or Chapter 2 in book Burton & Shah, pp 1-51

The Milton Friedman argument for market efficiency in the presence of “noise traders” If noise traders are truly “random,” then their effects will “cancel out.” (Kind of a law of large numbers result) Noise traders are “systematic,” then arbitrage traders will “trade against them” and take all of their money Thus prices will be efficient in either case

The Efficient Market Hypothesis (according to Fama 1970) Three forms: Weak Semi-strong Strong Differ by what information is used Weak – past stock prices and returns Semi-strong – publicly known information Strong – all information including private

Fama’s Conclusions Weak form strongly supported by data Semi-strong seems to be supported but Some evidence of return correlation Strong form contradicted by market maker study

Others: Shiller: focuses on who volatile stock prices are relative to how stable are the things that are supposed to determine stock prices – expected future interest rates, dividends, etc. Malkiel: argues that it is extremely difficult to “beat the market” implying that that must mean that EMH is likely to be true Shleifer: makes the “limits to arbitrage” argument to counter the Friedman view that arbitrageurs will make markets efficient

But “traders” saw things otherwise January tells the tale Blue Monday; Happy Friday Good market precede holidays Trading Rules Technical analysis (charting stock prices) Graham and Dodd “Security Analysis” 1934 Price momentum (related to charting) Booms and busts

The Law of One Price Can the same product trade at two different prices without some tendency for the two prices to converge to one another? Law of One Price says “no” But…….. Oct 19 1987 (22% drop with no information change) Royal Dutch Shell Closed End Funds Palm Pilot Stub Meanwhile: Kahneman and Tversky DeBondt and Thaler Winner’s Curse

The End