Finance for Normal People Chapter 11: Behavioral

Transcript:Finance for Normal People Chapter 11: Behavioral:
Finance for Normal People Chapter 11: Behavioral Market Efficiency Behavioral Market Efficiency Efficient markets in standard finance Eugene Fama described an efficient market as one “in which prices always fully reflect available information” “Available information,” however, is an ambiguous term, and so are the terms “public information” and “private information” Behavioral Market Efficiency The two versions of efficient markets and the two corresponding efficient market hypotheses Price-equals-value markets - Markets where investments prices always equal their intrinsic values Hard-to-beat markets - Markets where some investors are able to beat the market, but most are unable to do so Behavioral Market Efficiency The price-equals-value market hypothesis is false The hard-to-beat market hypothesis is true Why do so many investors believe that markets are easy to beat? Behavioral Market Efficiency “Why do active investors continue to play a negative sum game?” 1. Ignorance 2. Cognitive and emotional errors 3. Wants for expressive and emotional benefits Behavioral Market Efficiency Intrinsic value A cow for her milk, A hen for her eggs, And a stock, by heck, for her dividends John Burr Williams, The Theory of Investment Value Behavioral Market Efficiency Price-equals-value and hard-to-beat markets Warren Buffett received three bids from sellers of Citizens Insurance bonds, one at a price that would yield 11.33%, one at 9.87% and one at 6.00% "It's the same bond, the same time, the same dealer. And a big issue” Behavioral Market Efficiency Price-equals-value and hard-to-beat markets “This is not some little anomaly, as they like to say in academic circles every time they find something that disagrees with their [efficient market] theory“ Buffett referred to “efficient market,” but the term price-equals-value market would have been more pre­cise Behavioral Market Efficiency Price-equals-value and hard-to-beat markets Buffett cautioned investors not to jump too fast from evidence that markets are not price-equals-value markets to the conclusion that markets are not hard-to-beat markets Behavioral Market Efficiency Price-equals-value and hard-to-beat markets When asked “What advice would you give to someone who is not a professional investor,” Buffett said: “Well, if they’re not going to be an active investor – and very few should try that – then they should just stay with index funds. Any low-cost index fund… They’re not going to be able to pick the right price and the right time” Behavioral Market Efficiency Price-equals-value and hard-to-beat markets Investors might not care much about whether markets are price-equals-value markets But everyone