Poll: Are Market Movements Best Explained by EMH or Behavioral Finance — or Both?

Are financial markets efficient or not? This simple question has motivated thousands of pages of research with no concrete conclusion. An often-overlooked component of the efficient market hypothesis (EMH) is that active management cannot outperform the market on a risk-adjusted basis. Simply “beating” the market does not constitute outperformance because it often fails to account for various forms of risk. Another factor is time. Over what period can you outperform (on a risk-adjusted basis)?

Daniel Kahneman won a Nobel Prize in economics when he showed that investors are not perfectly profit seeking and display flawed behavior in different situations (e.g., investors tend to take risks to avoid losses and to lock in gains when probabilities suggest they should take risks). As the debate evolved, Andrew Lo of MIT published a paper on the adaptive markets hypothesis, which incorporates both EMH and behavioral elements.

At the 67th CFA Institute Annual Conference, which concluded last week, speaker Cliff Asness told delegates that he subscribed to elements of both the EMH and behavioral finance. When we polled the CFA Institute Financial NewsBrief audience, around 80% who answered the poll agreed with Asness. In the final analysis, is the EMH correct, or do markets reflect the tenets of behavioral finance? I think we can answer “yes.”

Which of the following statements reflects your opinion as to what best explains market movements?

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.