Inefficient Markets: An Introduction to Behavioral Finance (Clarendon Lectures in Economics)

The efficient markets hypothesis has been the central proposition in finance for nearly thirty years. It states that securities prices in financial markets must equal fundamental values, either because all investors are rational or because arbitrage eliminates pricing anomalies. This book describes an alternative approach to the study of financial markets: behavioral finance. This approach starts with an observation that the assumptions of investor rationality and perfect arbitrage are overwhelmingly contradicted by both psychological and institutional evidence. In actual financial markets, less than fully rational investors trade against arbitrageurs whose resources are limited by risk aversion, short horizons, and agency problems. The book presents models of such markets. These models explain the available financial data more accurately than the efficient markets hypothesis, and generate new predictions about security prices. By summarizing and expanding the research in behavioral finance, the book builds a new theoretical and empirical foundation for the economic analysis of real-world markets. The efficient markets hypothesis has been the central proposition in finance for nearly thirty years. It states that securities prices in financial markets must equal fundamental values, either because all investors are rational or because arbitrage eliminates pricing anomalies. This book describes an alternative approach to the study of financial markets: behavioral finance. This approach starts with an observation that the assumptions of investor rationality and perfect arbitrage are overwhelmingly contradicted by both psychological and institutional evidence. In actual financial markets, less than fully rational investors trade against arbitrageurs whose resources are limited by risk aversion, short horizons, and agency problems. The book presents and empirically evaluates models of such inefficient markets. Behavioral finance models both explain the available financial data better than does the efficient markets hypothesis and generate new empirical predictions. These models can account for such anomalies as the superior performance of value stocks, the closed end fund puzzle, the high returns on stocks included in market indices, the persistence of stock price bubbles, and even the collapse of several well-known hedge funds in 1998. By summarizing and expanding the research in behavioral finance, the book builds a new theoretical and empirical foundation for the economic analysis of real-world markets. Contents ......Page 6 Acknowledgments ......Page 9 1 Are Financial Markets Efficient ......Page 10 2 Noise Trader Risk in Financial Markets ......Page 37 3 The Closed End Fund Puzzle ......Page 62 4 Professional Arbitrage ......Page 98 5 A Model of Investor Sentiment ......Page 121 6 Positive Feedback Investment Strategies ......Page 163 7 Open Problems ......Page 184 Bibliography ......Page 207 Index ......Page 220 The Efficient Markets Hypothesis has been the central proposition of finance for nearly 30 years. This book, by one of the foremost US economists, presents an alternative view of financial markets: behavioral finance Andrei Shleifer. Series Statement From Book Jacket. Includes Bibliographical References (p. [198]-210) And Index. THE efficient markets hypothesis (EMH) has been the central proposition of finance for nearly thirty years.