Inefficient Markets: An Introduction to Behavioral Finance

by Andrei Shleifer

Book Overview

The efficient markets hypothesis has been the central proposition in finance for nearly thirty years. It states that securities prices in financial markets must equal fundamental values, either because all investors are rational or because arbitrage eliminates pricing anomalies. This book describes an alternative approach to the study of financial markets: behavioral finance. This approach starts with an observation that the assumptions of investor...

• Format: Paperback
• Language: English
• ISBN: 0198292279
• ISBN13: 9780198292272
• Release Date: April 2000
• Publisher: Oxford University Press
• Length: 224 Pages
• Weight: 0.60 lbs.
• Dimensions: 0.5" x 5.5" x 8.5"

Customer Reviews

Best introductory book on behavioral finance

As has been admitted by even the staunchest former proponents of financial economics (such as Burton Malkiel), the multi-decades old dominant intellectual field in academic finance has piled up against itself persistent anomalous data. Thus, it is no surprise, as the science of economics advanced, that a new intellectual field would develop to challenge and replace the old. Behavioral finance, which relaxes some of the key assumptions in financial economics, utilizes survey data, and integrates knowledge from psychology to better understand financial markets, is that new intellectual field. Although still controversial, young economists and financial professionals should become versed in this new field as early as possible: 1) because there is huge room for new research where creative economists can flex their muscle and 2) financial professionals that drop the old adherence to financial economics will have an edge over those that don't. Andrei Shleifer's work is the best introductory work on behavioral finance that I've come across, and I thus strongly recommend it to those who want a quick and easy to understand introduction to this field which is the wave of the future of academic finance (well, I hope). Robert Stephenson-Padron MSc student (economics & finance) University of Navarra, Spain

Arguments Against the Efficient Market Hypothesis

Inefficient Markets by Harvard economist Andrei Shleifer provides a strong argument against the Efficient Market Hypothesis (EMH) in its various forms and an introduction to Behavioral Finance. Shleifer's main points are summarized below. 1. The EMH comes in three forms. The Weak Form states that an investor can not achieve returns above the market averages based on the analysis of historical stock price patterns (Technical Analysis). The Semi-Strong Form states that all publicly available news is reflected in stock prices almost instantaneously and that an investor can not beat the market averages by diligently tracking company earnings and other events (Fundamental Analysis). Finally, the Strong Form says that an investor can not beat the market even by using information that is not available to the public (Insider Trading). The Strong Form can be dismissed by considering the number of corporate executives currently under indictment or serving time for insider trading. Evidence against the Semi-Strong and Weak Forms can be found in the Small Stock Effect (small stocks outperform the market) and January Effect (the market does best in January) which seemed to hold until they were widely publicized but have presumably been negated since then by arbitrage. Additional evidence against the EMH can be found in the less than perfect correlation between the price movements of Royal Dutch and Shell Transport and Trading shares which jointly own the Royal Dutch Shell enterprise in a fixed 60%/40% ratio. Furthermore, the prevalence of a 10% to 20% discount in the share price of closed end funds relative to their net asset values suggests that the market is less than efficient. 2. In Chapters 2-4, Shleifer demonstrates the limits of arbitrage in maintaining efficient markets. He develops a mathematical model for predicting the returns of arbitrageurs (who accurately perceive the values of stocks) and noise traders (who incorrectly perceive the same values). His Noise Trader Model explains how noise traders can sometimes achieve higher returns than arbitrageurs based on the "hold more" and "create space" effects. The "hold more" effect is based on the community of noise traders egging each other on as was seen in the technology bubble that burst in 2000. The "create space" effect says that the wider the range of incorrect perceptions held by noise traders, the less effective arbitrageurs will be in bring stock prices back to their correct values. Shleifer uses the Noise Trader Model to make additional predictions about the market behavior of closed end funds and shows that, unlike the EMH, it accurately models such phenomena as the rise in share price to the underlying net asset value upon liquidation or reorganization as an open end fund. Finally, he shows that professional arbitrageurs, such as hedge fund operators, are forced to adopt more conservative tactics than individual arbitrageurs by their need to retain clients and funding. 3. In Chapters 5 a

Necessary Book for Finance

The material in this book is necessary for anyone who is responsible for managing money or involved with a business entity doing trading in financial markets. Increasingly this is "everyone."The good news is that the conclusions and punchlines are presented clearly and simply. A person who does not want to follow the math (there is a lot of it) can skip to the arguments and conclusions and get an enormous amount of valuable information. The bad news is that little effort has been expended to make the math attractive. A person wishing to slog through the math will have to be prepared to sit down with pencil & paper & patience. Some editing by someone who cared would have made this book much more attractive to the average student. Martin Baxter & Andrew Rennie's "Financial Calculus" gives a good example of how this can be done.

Fabulous Book!

"Inefficient Markets" is the most thoughtful original treatment of behavioral finance I have found. Unlike most other books on this topic, which either are vapidly light but original or are intellectually rewarding but disjointed compendiums of previously published articles, Shleifer has produced an interesting and intelligent synthesis of behavioral finance. He organizes his materially logically and clearly, covering the central themes of behavioral finance in as unified a manner as the subject permits. He has clearly thought hard about the subject matter, and his book reflects this. Shleifer's writing style is both lucid and academically rigorous, which makes for an enjoyable and informative book.Shleifer begins by reviewing the theoretical and empirical foundations of the efficient market hypothesis (EMH) and introducing the principal challenges to this hypothesis. His review of the EMH is careful, objective, and respectful. His introduction to the principal challenges to the EMH is written with equal integrity, and his analysis of these challenges is non-dogmatic and relatively conservative. He carefully avoids overstating the conclusions of the academic research. While Shleifer clearly feels that financial markets are NOT efficient, as an academic he also acknowledges the inability of empirical research to PROVE with certainty that financial markets are or are not efficient. It is his careful interpretation of the evidence on both sides of the EMH fence that gives this book its tremendous credibility.The majority of "Inefficient Markets" covers the two principal building blocks of behavioral finance: the theory of limited arbitrage and the theory of investor sentiment. Shleifer demonstrates that arbitrage is of limited usefulness in relatively competitive markets, much less in more complicated environments, and that financial markets should not be presumed efficient. He then presents a model of investor sentiment that incorporates the results of experimental research into individual decision-making under conditions of uncertainty. Shleifer also provides an extremely clear overview of the DeLong et al. noise trader model, and concludes the book by highlighting some of the unsolved problems in financial economics.It should be noted, if it is not already clear, that this book is intended for PhD and advanced MBA students (in fact, the book is a core text for the University of Chicago's PhD course in Behavioral Finance). The analysis in the book is both theoretical and rigorous. Nonetheless, the intellectually curious reader with a basic exposure to microeconomics and/or financial economics will find the book rewarding. You are guaranteed to come away from this book knowing more about that opportunities and challenges facing the field of behavioral finance.For practitioners, or anyone looking for a more general/popular treatment of behavioral finance, I recommend "Beyond Greed and Fear" by H