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The document discusses the efficient market hypothesis (EMH) which states that stock prices instantly reflect all available public information and it is impossible to outperform the market. It also discusses behavioral finance as an opposing theory, noting that investor behavior is sometimes driven by psychology rather than rationality. As an example, it describes how Tesla's stock price is high due more to Elon Musk's personal brand and popularity rather than fundamentals. The document concludes that investors should use both behavioral finance and fundamental analysis strategies depending on market conditions.

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Асель Калиханова
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54 views

Essay

The document discusses the efficient market hypothesis (EMH) which states that stock prices instantly reflect all available public information and it is impossible to outperform the market. It also discusses behavioral finance as an opposing theory, noting that investor behavior is sometimes driven by psychology rather than rationality. As an example, it describes how Tesla's stock price is high due more to Elon Musk's personal brand and popularity rather than fundamentals. The document concludes that investors should use both behavioral finance and fundamental analysis strategies depending on market conditions.

Uploaded by

Асель Калиханова
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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The concept of efficient market strategy states that all existing information reflects the stock

prices immediately. There is no insider information in an efficient market, since all data
related to share prices are publicly available. According to this theory, it is impossible to
outperform the market neither by investing in undervalued stocks, nor implementing different
market strategies, since all securities are traded at their fair value. The followers of EMH
believe that there is no need to make the fundamental or technical analysis, because they
won’t help to outperform the market.
Most investors implement this theory in a security analysis. If the investors analyze the
company in detail, they can eliminate the risk of a drop in the price, since the securities are
already traded at their fair value. On the other hand, investors can not expect that the value of
securities will grow, because the stock prices have already reflected all publicly available
information. The proponents of this strategy believe that any event related to the company
affects the share prices, but after the specified time the prices will go back to their fair value.
As an example, we consider the event when the Portuguese football player Cristiano Ronaldo
pushed the bottle of coke away in a conference. After 30 minutes, the share price of “The
Coca Cola company” fell down to 1,6%. The value of the company decreased from $242
billion to $238 billion with $4 billion in loss. However, after a week the share price of Coca
Cola went back to its normal price.
In a portfolio management under the conditions of efficient market investors make a deep
analysis of each company. The publicly available information about the security may include
the financial statements, information about the management staff, reputation and objectives
of the company. Therefore, in an efficient market investors have in their portfolio the
securities of well-known and fairly valued companies.
The opposite strategy that criticizes the theory of efficient market strategy is behavioral
finance. It assumes that people are mostly led by psychology, rather than rationality. The
regular existence of anomalies is a contribution of behavioral finance. One of those anomalies
is the January effect. For investors, it is unlikely to purchase shares in January, since the
stock prices are relatively high this month. Mainly it is explained by the fact that in
December investors get rid of unnecessary shares at the end of the year for tax benefits.
Therefore, not all people are ready to sell the securities in January, then it increases the share
prices in the market. This explanation is applicable for many countries, however it is unclear
why the stock prices are higher in January in countries without tax benefits.
Behavioral finance is one of the main reasons for “bubbles” in the economy. Investors
aspired by the quick gains, success of the company may put their money in the company
without any prospects to grow. Then, these companies still exist because of the belief of
investors. One of the examples of so-called companies is Tesla. Mainly the success of Tesla
is related to the idea of producing electric cars which are eco-friendly. The social impact and
popularity of the CEO of Tesla - Elon Musk also make Tesla one of the most valuable
companies. However, in the car market there are many alternatives to Tesla cars, which also
have all the functions that Tesla has. Tesla hasn’t paid any dividends to its shareholders,
almost all investors are waiting for higher returns on the investments. The company is
successful thanks to the personal brand of Elon Musk, zev- loans and the support of the
government. The fundamental analysis assumes that this company is not the best company to
invest in, nevertheless, investors still put their money in because of the effect of behavioral
finance.
In order to eliminate the risks and use money wisely, investors should use appropriate
strategies for stock selections. Depending on the current situation in the market, investors
implement both behavioral finance and fundamental analysis. The market we operate in is not
always efficient, therefore in security selections investors have to make a deep fundamental
and technical analysis, read the financial statements and monitor the reputation and products
of the company amid contributors.

References:
1. CFA Institute. 2022. Efficient Market Hypothesis: Validity & Criticisms | CFA
Institute Summary. [ONLINE] Available at:
https://www.cfainstitute.org/en/research/cfa-digest/2003/11/the-efficient-market-
hypothesis-and-its-critics-digest-summary. [Accessed 13 September 2022].

2. Rebecca Baldridge. 2022. What Is the Efficient Market Hypothesis? – Forbes


Advisor. [ONLINE] Available at: https://www.forbes.com/advisor/investing/efficient-
market-hypothesis/. [Accessed 13 September 2022].
3. AMG Funds. 2022. The Psychology of an Investor - AMG Funds. [ONLINE]
Available at: https://www.amgfunds.com/research-and-insights/investment-
essentials/psychology/the-psychology-of-an-investor/. [Accessed 13 September
2022].

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