Tuesday, October 14, 2008

Efficient Markets or ... Herd Get Slaughtered

Rational Expectations Theory is cornerstone of modern economics. It implies that markets work highly or at least quite efficiently and this, applied to equity markets, has been described as Efficient Market Hypothesis. Under efficient markets conditions assets are priced fairly and reflect all available information. But do someone still believes that this applies to real-world markets?
Greenspan talks about irrational exuberance. Stock market crashes tended to repeat from beginning of securities trading - from South Seas Bubble, through Japan late 1980s stock crash until recent credit crunch downturn. And if equity markets are irrational can better informed traders profit from its irrationality?
The efficiency problem is clearly interconnected with investment strategies as inefficient markets would imply possibility of risk unadjusted profits and vice versa - abnormal profits point to market inefficiencies. The connection between equity market efficiency and investment strategies is focus of my MBA dissertation. It evaluates and compare common investment strategies based on time series of market data since 1990 until 2008. While some of the conclusions are at odds with popular notions on the stock market they are well consistent with other academic research on the subject and can provide framework for equities investment decision-making. The work is free to download following link bellow.