Question

Using the market efficiency theories and theories of investment behavior, how do you explain the significant investor losses experienced during the mortgage crisis and resulting recession? In your discussion, address your assessment of the level of efficiency present in the mortgage and mortgage derivatives markets, as well as the investor behaviors that contributed to the market performance.

Answer 1

Mortgage crisis in 2008 which resulted into significant destruction of wealth can be attributed to various cognitive biases of different individuals on the part of investments which would be factors like over optimism and following the herd and staying overconfident on his Investments.

It can also be attributed to the fact that market will be reflecting to new informations in an Efficient market so these informations which were arising out of insolvencies of the companies which were completely new and there was extreme reactions on the part of the shareholders so it can be said that it was a reflection of the market efficiency that market was moving on new informations which was leading to a lot of uncertainty.

There is a significant level of efficiency which is present in the mortgage market and which can be said to be Semi efficient in nature because all the publicly available information has been discounted in the price but privately available information are yet to be discounted so there is always a scope for the insider trading as those inside are properly aware of the high level of exposure they were into, in order to make a high level of Return during the mortgage crisis.

So, Subprime mortgage crisis can be attributed to factors like semi Efficient market efficiency and cognitive biases on the part of the Investors.