Question

1. Research documents that firms with high historical returns in the last six months will continue such performance in the next six months, which is termed as momentum in literature. How will you explain this finding if you believe in EMH? What will be your explanation if you believe in behaviour finance? (20 marks)  

Answer 1

Efficient market hypothesis advocates that all the privately available information and the publicly available information have already been discounted into stock price & there is no scope for making any additional rate of return and there is no scope for beating the index rate of return so it always promotes for passive investment. Efficient market hypothesis also underlines that past prices can't be used for future outperformance.

In this case, it can be seen that a prediction has been made regarding momentum investing and in efficient Markets, there is no protection which can be made regarding performance and there is no certainty as only the index rate of return will be the supreme so this is not in accordance with Efficient market hypothesis and this is violating the concept of Efficient market hypothesis

Behavioural finance will always believe that investors can make higher rate of return by studying various kinds of chart and patterns and reflecting upon their behaviour and biases and according to the behavioral finance, the firm with historical return can be outperforming in next six months, & It will be in accordance with the behavioral finance and they will not be violating the Behaviourial Finance theory.