Stock market efficiency: Emergence of the behavioral paradigm

Abstract

The aim of this article is to assess the emergence of behavioral finance while challenging firstly the efficient market hypothesis (EMH) which has been considered the cornerstone of modern finance. Indeed, the HEM assumes, theoretically, the market is said to be efficient if the price of financial instruments accurately reflects all available information about the financial assets, which in turn assumes that future information is unpredictable and the price of each financial asset follows a random evolution, and that there are therefore never any errors in valuations. The second part is devoted to an analysis of the various anomalies in the efficient market hypothesis, in particular the irrational behavior of investors/stock market participants, and the errors they can make, which have been largely neglected by the EMH in the development of management processes since they are considered as and qualified as noisemakers, and in transition the impact on stock markets, as well as the rational explanations for the under-reaction to information.

Finally, we discussed the contribution of behavioral analysis to the explanation of (i) stock market anomalies through analysis of the link between disposition heuristics and underperformance reflecting excessive market volatility. Such behavior leads investors to sub-optimal portfolio management, the origins of which can be multiple, and (ii) the link between excessive trading and overconfidence bias.

Keywords: Financial market efficiency, behavioral finance, market anomalies.

JEL classification: G10, G14, G41.

Paper type: Theoretical Research