Question

Please provide your thoughts about the validation or failure of the theory of efficient markets and behavioral finance given the "credit crunch" or global financial crisis of 2007-2009.
IIt is important to add citations and references.

Answer 1

The efficient market hypothesis states that the stock prices include all the relevant information and so it is efficient in nature. The efficiency of the stock market cannot br beaten by anybody. This implies that all the necessary information is taken into account by the stock prices in the market. But during the financial crisis of 2007 - 2009, this was found to be false. Many thinkers and scholars questioned the theory of market efficiency. But it should be taken into consideration that the theory has certain assumptions and limitations. Firstly, it assumes that the market place is a perfect market and that there us free flow of all information at all time. These assumptions are not valid in real markets. Moreover, the theory has a limitation that it takes past data into account i.e. it is a backward looking theory instead of a forward looking or futuristic one. Thus, it can be said that the theory of market efficiency or the efficient market hypothesis and behavioral finance cannot be considered as a failure or it cannot be blamed upon these theories for lack of identification of an upcoming crisis. Our markets are not perfect markets for these theories to hold true. Therefore, it needs to be understood that proper regulation of the markets is imperative.

Reference:

Ball, Ray (2009). The Global Financial Crisis and the Efficient Market Hypothesis : What have we Learned? Journal of Applied Corporate Finance

Siegel.J (2010) Efficient Market Theory and the Recent Financial Crisis.