Question

Please provide your thoughts about the efficient market hypothesis (EMH) and how the 2007-2009 recession are related. Please add citations and references.

Answer 1

The Efficient Market Hypothesis (EMH) states that all the available information totally reflects in the prices of a stock. It is based on the idea of a random walk where it is believed that prices of the stocks follow a random walk, therefore we cannot predict tomorrow’s stock price based on today’s stock price. The prices of the stock react only to the new information not to the old information and it is impossible to beat the market in long run by timing the market.

But in real world there are deviations from the efficient markets hypothesis because of investor’s psychology; sometime investors are bias in their approach therefore sometime it is difficult for investors to take advantage of mispriced securities. The behavior of investors is different in different market conditions. The stock market events like 2007-2009 recessions raise doubt on the notion of a random walk because there may be unexploited profit opportunities in these events.

The Great Recession was a period of economic decline in the U.S. in 2007- 2009. It has followed the financial crisis of 2007-08 in the country and U.S. subprime mortgage crisis. The Great Recession has resulted in the shortage of required assets in the economy and also the collapse of the financial sectors. In my opinion it is more related to investor’s sentiment and can be better explained by Behavioral finance which is based on human psychology.