Criticisms of Efficient Market Hypothesis

Criticisms of Efficient Market Hypothesis.

Stock Prices often reflect evidence of:

  • Irrational exuberance – people getting carried away by booms and asset bubbles (e.g. US house prices in 2000s, Dot Com Bubble and Bust.
  • Behavioural economics places greater emphasis on the irrationality of human behaviour in making economic decisions e.g. herding effect e.t.c
  • see also: herding effect

Empirical evidence that stock prices do not reflect. E.g. According to Dreman, in a 1995 paper, low P/E stocks have greater returns.

Even the founder of EMH, E.Fama found in a 1990s study that many stocks didn’t follow a random walk model but that ‘value’ stocks outperformed. They also found a ‘momentum effect’ where stocks which had done well in the past, often continued to do well in the future. Fama, tried to defend his theory by saying cheap stocks had a greater risk.

Joseph Stiglitz published a proof saying that if the efficient market hypothesis was true it would be logically irrational to spend money on research – which people clearly do.

An Economic Model turned to myth. – The Myth of the Rational Market by Justin Fox
Book Cover

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