MARKET EFFICIENCY VERSUS BEHAVIORAL FINANCE

MARKET EFFICIENCY VERSUS BEHAVIORAL FINANCE
A discussion with Burton Malkiel. Princeton University and Sendhil Mullainthan, Harvard University

There two side in this debate.
Malkiel is a Efficient Market Hypothesis person, who publish book A random Walk Down Wall street.
Malkiel “There he maintained that stock price fallow a random walk and cannot systematically be predicted by stock markets professional –Underpinning- tenets of finance: market are efficient, meaning that they are rationally and accurate reflect all publicly available information.(note: Efficient Market Hypothesis EMH live for about 30 or 40 years with their all controversy)
Sendhil Mullainathans, behavioralist, “focused on when and how a human behavior differs from rational and not, profit seeking behavior typified by proponents of market efficiency” —believe—human have a limit to their cognitive abilities and their willpower, and may not always act rationally.
Malkiel: On average you can’t beat the market and so you’re better of with the index
Mullainathans: the era of MHT is over: see the market anomalies – tries to patch up the original model by attributing the anomalies to missing risk factor and adding those risk factor to the a model. (market is not a simple as returns and data)
Malkiel—recommended a index fund—principle “looking needle in a haystack is difficult, so its better if you just buy the hay stack”, because based on the data, if you buy a fund index is better than if you try to finds a good fund to be invest.
Are stock Price Predictable?
EMH : one cannot predict stock prices on their future trend.
Mullainathans –behavioralis- see there are some market inefficiencies, and we do some predictable.
Malkiel: still recommend a index—“ so I think there is a little predictability in term of when return are going to be high or low, but enough to do an investors any good, because nobody can predict when the market will turn”
Stangle: “Underpinning of the EMH is that price always correct, fully ratinal, and that they reflect all available information.”
EHM—price is unpredictable
Behavioralis – stock price is weakly predictable
How Does the EMH Account for trading volume?
Malkiel: trading basically driven by re-balancing and liquidity needs; the principle “EHM, there’s little room for differences among investors, because the only reason for differences in belief would be differences in information”
Mullainathans: the principle “In behavioral view, however, people can have differences of opinion because they have different biases, not just different information:, those different create the ability for behavioral model to generate tons of volume
Rationally and Arbitrage
EHM: profit maximization and self-interest are what drive investor’s activity.
Behaioralist: there are other models of human endeavor and utility, including altruism, or caring for someone else.
Malkiel: Individual may act altruistically, butt that doesn’t make the market altruistic—there are enough rational trader that there are no arbitrage opportunities.
Mullainathans: Sometimes there are good arbitrage opportunities in market that are just opening up, where the arbitrageurs haven’t had a chance to enter completely.
Investors Choice and public policy
Malkiel: As a nation, we are under savers
Mullainathans: feel that choice is goods, and more choice is better, which has clear policy implication. But behavioral finance suggest that more choice may not be good, which has very different policy implication.
How do the experts invest their money
Malkiel: suggest thei put the money majority in index fund, but he do buy some individual stock
Mullainathans: “I’ve given up that type of activity, mainly because this is not how you make money. I’ve learned that it is too far too easy to convince yourself that you’ve found a good opportunity.
Will EMH survive?
Malkiel: I think they can do co-exist, because there are some insight from behavioral finance that are very important for investors, but I think the bottom line is that whether you’re a behavioralist or an efficient markete person, you’re both coming out with the same advioce. The behavioralist and I my disagree about some things, but we both have exactly the same advice for investors: buy an index fund