Module V·Article I·~1 min read
Behavioral Finance: Why Markets Are Not Always Rational
Psychology of Investors and Markets
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The Challenge to the Efficient Market Hypothesis
The efficient market hypothesis (Eugene Fama) claims: asset prices reflect all available information. Consequence: it is impossible to systematically "beat" the market.
Behavioral finance (Kahneman, Shiller, Thaler) demonstrate: markets can be systematically inefficient, because investors are people with cognitive biases.
Market Anomalies
Momentum: stocks that have risen during the past 12 months continue to rise (and vice versa). This contradicts the random walk hypothesis.
Value premium: stocks with low P/E, P/B systematically outperform "expensive" stocks in the long run.
January effect: shares of small companies systematically increase in January.
Reaction to news: the market often over- or underreacts to news.
Aggregate Biases
If most investors are subject to the same biases, their mistakes are not compensated at the market level—they are amplified. Market bubbles and panics are the result of aggregated cognitive biases.
Limits of Arbitrage
In theory, rational arbitrageurs should correct price anomalies. In practice: "the market can remain irrational longer than you can remain solvent" (Keynes). Short-selling is difficult and expensive.
Practical Assignment
Choose three decisions from your investment or business experience. (1) Which cognitive biases could have influenced them? (2) How could the market (or your counterparties) have been irrational? (3) How can future decisions be structured to reduce the influence of biases?
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