Should market efficiency be abandoned for behavioral finance?
This material may consist of step-by-step explanations on how to solve a problem or examples of proper writing, including the use of citations, references, bibliographies, and formatting. This material is made available for the sole purpose of studying and learning - misuse is strictly forbidden.The traditional concepts in finance have been based on the premise that investors act in a rational manner. As per the tenets of “market efficiency”, efficient markets imply that the market value of the asset and the intrinsic value are the same. The fundamental value of any asset can be found by ascertaining the present value of all cash flows which are expected to accrue from the asset over the life of the asset. The cash flows are discounted at the opportunity cost to find the intrinsic value of the asset. Market efficiency states that a trader cannot beat the market and earn excess returns or positive alpha when the markets are efficient since there are no opportunities for arbitrage in efficient markets. In order to earn excess returns, it is important that the trader is able to find out the deviations of the market price from the fundamental value of the asset and accordingly buy undervalued assets and sell the assets which are overvalued. However, this is not true and markets cannot be termed to be efficient since there are deviations in the market prices of assets from their intrinsic value during periods such as period of bubble. The recent...