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For
the last thirty-some years, the Efficient
Market Hypothesis
(EMH) has been the central proposition
of modern finance. In his classic statement, Fama
defined an efficient market as one where security
prices always fully reflect all available information.
Therefore an average investor can not hope to
consistently outperform the market, and any resources
allocated to analysing, selecting, or trading
securities is but a waste. Smarter would be to
passively invest in the market, and to put aside
any efforts of active investment management.
In
its first decade, the EMH was a celebrated success--both
in a theoretical and an empirical sense. However
in the succeeding two decades, we have seen numerous
studies reversing some of the earlier evidence
supporting the EMH. With this new evidence, emerged
Behavioural Finance
as an alternative perspective.
Behavioural
finance is the study of human fallibility in financial
markets. At the moment, the area is in an awkward
state. There is still a strong bond with the old
modern finance school of thought. And yet there
is a tugging desire to somehow incorporate or
deal with some of the less concrete, fuzzier aspects
of our human psychology. So far the adjustments
have been within the boundaries of "modern finance
acceptability", and no revolutionary steps have
been taken. Consequently, we are not any closer
to revelling in what could be termed a practical
investment framework--i.e. something to mold our
perspective, something that gives us an edge when
investing, something that might make us better
investors. In this sense the Theory of Wild Beasts
is different.
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