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Efficient capital markets and the importance of behavioral finance

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ING Group Greece - Sidma SA - Telesis Securities
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  1. Abstract.
  2. Introduction.
  3. The Efficient Market Hypothesis (EMH).
    1. Efficient Market Sub-Hypotheses.
    2. The importance of Informational Efficiency.
  4. The importance of Behavioral Finance.
    1. Behavioral Finance and the utility function.
    2. Behavioral Finance and the fusion investing.
    3. Behavioral Finance and the arbitrage limitations.
  5. Implications of Efficient Capital Markets.
    1. Efficient Capital Markets and technical analysis.
    2. Efficient Capital Markets and fundamental analysis.
  6. Conclusions.

Efficient capital markets allow to consumers and companies to invest savings, borrow, and manage risk in the most effective way. Capital markets bring together companies, that seek to raise capital to invest in future performance and investors, who seek for a profitable return on their investments.
Investors trade for both cognitive and emotional reasons. Behavioral Finance examines the psychological traits of investors, investigates the factors that contribute to capital market efficiency and tries to explain portfolio allocations that are inconsistent with the paradigm of the expected utility of wealth.

[...] The implications of efficient capital markets are related to technical and fundamental analysis. Technical analysis does not measure a security's intrinsic value and the frequency, in which statistical forecasting produces expectations for future activity, cannot disseminate the new available information. Technical trading cannot take advantage of this new information since when new information is public, price adjustment has already occurred and is already impounded in the current trading price. Fundamental analysis estimates a security's intrinsic value as to make superior market timing and take advantage of the new available information. [...]

[...] This paper investigates the importance of Behavioral Finance in efficient capital markets. The Efficient Market Hypothesis (EMH) and its division to three EMH sub-hypotheses (weak-form EMH, semistrong-form EMH and strong- form EMH) are presented in section 1. Also, the importance of informational efficiency is explained in relation to funds allocation to the highest- valued projects in order to mirror the fundamental value of the future cash flows. In section the importance of Behavioral Finance is analyzed in the context of Utility Function, Fusion Investing and Arbitrage Limitations. [...]

[...] Otherwise, market is unbeatable for an extended period of time and investors should just index, or buy and hold all the stocks in the market The importance of Behavioral Finance The main question that arises in regards to efficient capital markets is whether security prices have indeed significant real-time implications for investors and portfolio managers. Apart from analyzing financial models, investment research has to investigate the behavior of investors as well in order to conclude whether investors, driven by emotion, can lead markets off-center. [...]

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