Efficient Markets Theory and Behavioural Finance Essay

Efficient Markets Theory and Behavioural Finance - Essay Example In this theory, therefore, assumptions are done perpetuating that the information organisation and the behaviour of market participants systematically control individuals’ decisions in investment and the outcomes of the market. According to (Malkiel, 2003) the efficient market theory, has implications of theoretical perspectives to the market trends, while it ignores or underestimates the practical perception of the market. On the other hand, the behavioural finance theory has been thought of being more practical based and focused on people’s behaviour (Ashta & Patil, 2007). Following the event of the financial crises in 2007 to 2010, contention has developed amongst various authors on its implication to the popularity of the already criticised efficient markets theory and its contribution to the upsurge of the prevailing interest in behavioural finance theory. This paper compares and contrasts the explanations of efficient market theory and behavioural finance with reg ard to the financial crisis 2007 to 2010 and identifies the explanation considered to be strongest. The efficient market theory upholds the notion of the randomness in stock prices, based on short-run serial relationships amid successive changes in stock prices (Malkiel, 2003). Such was the case in the year 2001 when the US economy experienced a recession, followed by a boom that led to the dotcom bubble, and accounting scandals. The behavioural market theory regarded such occurrences in a different way from that of the efficient market theory, in that, the fears in individuals’ mind of a recession were considerable. Therefore, in regard to the recession in 2001 being disregarded, the stock market was thought of as not having a memory of the way the price of a stock behaved in the past, so as to determine its future behaviour. The randomness inefficient market theory is questionable, due to the high frequencies with which successive moves towards the same direction occurred in the period of 2001 and 2003 when subprime mortgage grew from 2001 to 2005.  Ã‚