Compare and Contrast the Efficient Market Theory and the Behavioral Finance Theory. in Your Opinion, Which Is the Most Reflective of Market Behavior?

...

The prospect theory is based on irrational human behavior and claims that investors make decisions based on little information, despite large volumes of information being available. Another concept of the behavioural finance theory is known as ‘anchoring’. This is when an investor has a tendency to direct their decision-making process towards a single value, which will be amended, in order to generate the solution – these are typically inadequate and lead to irrational purchases.

To conclude, modern day financial philosophy takes into account the significant impact of investor behaviour. I believe that the behavioural finance theory is the most realistic and relevant hypothesis as it focuses more on the psychological aspects of human decision-making whereas the efficient market theory focuses on the natural price movements and claims that investors cannot outperform the market. In anxious and volatile markets, behavioural finance is more applicable as investors with less knowledge can ‘follow the herd’, buy stocks that are rising in price, or sell their shares when prices are falling. On the other hand, the efficient market theory insinuates there are no bargains and the only way to establish income is through riskier purchases, which is untrue.

---------------------------------------------------------------

Bibliography

Anastasios Konstantinidis, Androniki Katarachia, George Borovas and Maria Eleni Voutsa. (na). From Efficient Market Hypothesis To Behavioural Finance: Can Behavioural Finance Be The New Dominant Model For Investing?. Available: http://economic.upit.ro/repec/pdf/2012_2_2.pdf. Last accessed 4th Nov 2015

Albert Phung. Behavioral Finance: Key Concepts - Prospect Theory. Available: http://www.investopedia.com/university/behavioral_finance/behavioral11.asp. Last accessed 4th Nov 2015.

Albert Phung. Behavioral Finance: Key Concepts - Herd Behavior. Available: http://www.investopedia.com/university/behavioral_finance/behavioral8.asp. Last accessed 4th Nov 2015.

Dr. Rohit Kishore. Theory of Behavioural Finance and its Application to Property Market: A Change in Paradigm.. Available: http://www.prres.net/papers/kishore_behavioural_finance_application_property_market.pdf. Last accessed 4th Nov 2015.

Eugene F. Fama. (1997). Market efficiency, long-term returns, and behavioral finance. Available: http://m.e-m-h.org/Fama98.pdf. Last accessed 4th Nov 2015.

Investopedia. Securities Markets - Weak, Semi-Strong and Strong EMH. Available: http://www.investopedia.com/exam-guide/cfa-level-1/securities-markets/weak-semistrong-strong-emh-efficient-market-hypothesis.asp. Last accessed 4th Nov 2015.

Jason Van Bergen. (2011). Efficient Market Hypothesis: Is The Stock Market Efficient?. Available: http://www.forbes.com/sites/investopedia/%202011/01/12/efficient-market-hypothesis-is-the-stock-market-efficient/. Last accessed 4th Nov 2015.

Jonathan Clarke, Tomas Jandik, Gershon Mandelker. The Efficient Markets Hypothesis. Available: http://m.e-m-h.org/ClJM.pdf. Last accessed 4th Nov 2015.

Robert J. Shiller. From efficient market theory to behavioural finance. Available: http://aida.wss.yale.edu/~shiller/pubs/p1055.pdf. Last accessed 4th Nov 2015.

Wikipedia. (2015). Efficient-market hypothesis. Available: https://en.wikipedia.org/wiki/Efficient-market_hypothesis#Criticism_and_behavioral_finance. Last accessed 4th Nov 2015.

Berk, J and DeMarzo, P, 2014, Corporate finance, 3rd Edition (Global edition), Pearson/Prentice Hall, Chapter 13.