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Stock Market Anomalies - Essay Example

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According to Schwert (2003) "These [research] findings raise the possibility that anomalies are more apparent than real. The notoriety associated with the findings of unusual evidence tempts authors to further investigate puzzling anomalies and later try to explain them…
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Stock Market Anomalies
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Stock Market Anomalies Introduction According to Schwert (2003) "These [research] findings raise the possibility that anomalies are more apparent than real. The notoriety associated with the findings of unusual evidence tempts authors to further investigate puzzling anomalies and later try to explain them. But even if the anomalies existed in the sample period in which they were first identified, the activities of practitioners who implement strategies to take advantage of anomalous behavior can cause the anomalies to disappear (as research findings cause the market to become more efficient)."
In finance, anomalies are market activities not in agreement with the forecasting of the efficient market hypothesis (EMH). In detail, these anomalies seem to breach premises of mean-variance ratio or no-arbitrage. If a multifarious adaptive scheme approach better depicts markets, the supposed anomalies investigators have keyed out may not be abnormal after all.
The modern EMH model can be summed up in the "three P's of Total Investment Management" (Lo, 1999): prices, probabilities, and preferences. The three P's have originated from one of the most fundamental and vital estimates of modern economics, the rationale of supply and demand. This precept submits that the price of any goods and the quantity sold are fixed by the intersection of supply and demand arcs. The intersection of these two arcs influences "equilibrium" comprising the pair of price-quantity which might satisfy both the user and the producer at the same time.
How or why do markets fail Several reasons can be attached to this question. But the simplest reason is the heterogeneity of the investors which breaks down and the every capitalist starts to act in harmony which leads to either extreme optimism which is greed or pessimism which is fear. The teachings of social psychology are that people like to imitate one another thus giving weightage when being in group rather than to individual's own reflections. These varieties of breakdowns, even though rare, furnish investors with substantial chances to realise extra rates of return.
Random Wall Theory
According to Fama (1965) "weak form efficient market hypothesis (EMH), stated that the current asset price is determined only by its historical prices (information set) of that particular asset. If stock price failed to reject the random walk hypothesis (RWH), this implies that the future returns are unpredictable by using information on past returns. On the other hand, if the stock prices is characterised by a mean reverting (trend stationary) process, then there is a tendency for the price level to return to its trend path."
References
Lo, A., 1999, "The Three P's of Total Risk Management", Financial Analysts Journal 55, pp.87 to 129.
Fama, E.F., 1965. "The Behaviour of Stock Market Prices". Journal of Business, 38: pp.34-105.
Schwert, William, G. 2003. "Anomalies and Market Efficiency," in The Handbook of The Economics of Finance, Constantinides, Harris, and Stulz, eds. (Amsterdam: Elsevier, 2003), 941. Read More
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