1. Behavioral Finance
Economics 437

2. Review of EMH
Four Different Articles addressing what EMH means and the history of Behavioral Finance
Shleifer (Chapter 1)
Schiller (on Collab at course website)
Malkiel (on Collab at course website)
Fama (on Collab at course website)

3. Reading (starting Jan 25) “Noise Trading” – Limits to Arbitrage
Black on Toolkit
Shliefer on Toolkit or Chapter 2 in book
Burton & Shah, pp 1-51

4. The Milton Friedman argument for market efficiency in the presence of “noise traders”
If noise traders are truly “random,” then their effects will “cancel out.” (Kind of a law of large numbers result)
Noise traders are “systematic,” then arbitrage traders will “trade against them” and take all of their money
Thus prices will be efficient in either case

5. The Efficient Market Hypothesis (according to Fama 1970)
Three forms:
Weak
Semi-strong
Strong
Differ by what information is used
Weak – past stock prices and returns
Semi-strong – publicly known information
Strong – all information including private

6. Fama’s Conclusions Weak form strongly supported by data
Semi-strong seems to be supported but
Some evidence of return correlation
Strong form contradicted by market maker study

7. Others:
Shiller: focuses on who volatile stock prices are relative to how stable are the things that are supposed to determine stock prices – expected future interest rates, dividends, etc.
Malkiel: argues that it is extremely difficult to “beat the market” implying that that must mean that EMH is likely to be true
Shleifer: makes the “limits to arbitrage” argument to counter the Friedman view that arbitrageurs will make markets efficient

8. But “traders” saw things otherwise
January tells the tale
Blue Monday; Happy Friday
Good market precede holidays
Trading Rules
Technical analysis (charting stock prices)
Graham and Dodd “Security Analysis” 1934
Price momentum (related to charting)
Booms and busts

9. The Law of One Price
Can the same product trade at two different prices without some tendency for the two prices to converge to one another?
Law of One Price says “no”
But……..
Oct (22% drop with no information change)
Royal Dutch Shell
Closed End Funds
Palm Pilot Stub
Meanwhile: Kahneman and Tversky
DeBondt and Thaler
Winner’s Curse

10. The End