The efficient Market Hypothesis (EMH), also known as the efficient market theory, states that share prices indicate that all the information and consistent alpha generation are unattainable. This indicates that stock prices are always at their specific fair value whenever exchanges occur, hence impossible for stockholders to buy undervalued stocks or sell them at increased prices (Hsu and Wu, 2019).
Therefore, the stock owners cannot outperform the entire market, including using expert stock choosing methods or timing. Thus, investors can get higher returns by buying riskier bonds. Prof. Eugene Fama won the prize for formulating the theory, which he supported with all possible facts. However, Prof. Richard Thaler also won the prize for successfully criticizing the idea (Sharma, 2016). This was possible because it was a theory in development, subject to scholarly analysis for the idea’s existence. Therefore, the theory is valid, though it is still in its evolving phase, and will settle when experts have revised it and come to the point of agreement concerning the hypothesis.
An event study refers to the experiential analysis that examines the effects of a stimulant occurrence or contingent incident on a security’s value, such as the stock of an organization. Such a study exposes the crucial information regarding how security can react to any particular event. A security’s value can be affected when the company fills for protection against bankruptcy, merger announcements, or an organization defaults on its obligations to repay debts (Bash and Alsaifi, 2019).
Event study helps determine how a particular specific event happening within a firm can affect its stability by assessing its impact on its stock. Therefore, using the same statistical tool to analyze an event or a series of similar events, an analyst can develop a model that can help forecast stocks’ responses to any particular event.
Even though events analysis can result in effective models, which can predict future stock prices, sometimes, analysts can get abnormal returns. An abnormal return refers to the unusual large profits or losses, which result from any specific portfolio invested over a given time (Habibi et al., 2020). Therefore, instead of giving an acceptable return, such an analysis yields a diverging performance, which is inconsistent with the return rate. Such returns can point to systematic issues within the organization’s financial operations, such as fraud or data manipulation (Lebelle et al., 2020). However, such returns should be mistaken for being excess returns or alpha, which results from effective investment management. An abnormal return can be calculated as follows:
Er = Rf + β (Rm – Rf)
Where Er represents the security’s expected return, Rf represents the risk-free rate, which is the savings deposit rate, β symbolizes the risk coefficient of the security compared to the market, and Rm= Return on the market.
I have studied different behavioral critiques, which include irrational behavior. Financial works of literature indicate investor irrationality as one of the main aspects of financial behaviors. Irrational investors are subjugated by their emotions and thus are controlled by their animal spirits. Many investors fail as a result of their baser instinct and their overly speculative nature. Therefore, most lenders are subject to several cognitive predispositions and defects, such as myopia, antipathy, and self-confidence (Igual and Santamaría, 2017). Consequently, the investors become weary due to their pessimism and optimism, thus resolving impulsive investment practices, which become disastrous.
Irrationality cannot be fully explained from the theoretical perspective, which makes it a complex attribute. For instance, if investors were rational, it would be easier for them to aim for the worst outcomes, yet in reality, lenders hope for the best results from the businesses they finance. However, uncertainly also plays a crucial role in any investor’s behavior as it results in deep thinking and making an informed decision from
In the Biased Coin Toss game, I displayed irrational behavior most of the time. For instance, in tossing the coin, I only wanted it to show the head or tail depending on winning. I not only focused on any specific side of the coin and depended on the number of circumstances resulting in winning from the biased sides. However, I also realized that not knowing the outcome in advance put me in two different situations. I was afraid to toss the coin for fear of getting the wrong outcome and losing my stake. At the same time, I was optimistic that the outcome would be the one I desired, hence would get a return from tossing it. I settled specifically on tossing it between the two choices since if I tossed it, I had two possible outcomes, but if I did not, I had no chance.
Initially, I went to the Hargreaves Lansdown website to obtain the data on bond prices. I chose Brit Insurance Holdings N.V. and checked their coupon rate, the share price, par, and the annual coupon. Based on the data I collected, the company’s holding period return over the ten years is Brit Insurance Holdings the HPR over ten years is almost 70.7%. The YTM (Even) is 7.011%, while the YTM (Uneven) is 7.084%. These findings indicate that if one was to buy this bond, the investor should know that its yield to maturity presently, and holding it to the bond’s maturity results in an annualized return of 7.084%.
As indicated in the above example using actual data, the increase in bond prices decreases the yields. For example, if an investor buys a bond that is supposed to mature in ten years and has a face value of £1000 and a 6.725% annual coupon rate, it follows that the bond will be paying an interest of £100, which corresponds to 10%. This indicates that its coupon rate is obtained by dividing the bond’s interest by its value.
Reference List
Bash, A. and Alsaifi, K., (2019) ‘Fear from uncertainty: An event study of Khashoggi and stock market returns’. Journal of Behavioral and Experimental Finance, 23, pp.54-58. Web.
Habibi, A., Heidarpoor, F. and Tavangar, A., (2020) ‘Investigating the effect of conservatism on abnormal returns at the portfolio level’. International Journal of Finance & Managerial Accounting, 5(19), pp.163-173. Web.
Hsu, A.W.H. and Wu, G.S.H., (2019) ‘The fair value of investment property and stock price crash risk’. Asia-Pacific Journal of Accounting & Economics, 26(1-2), pp.38-63. Web.
Igual, M.G. and Santamaría, T.C., (2017) ‘Overconfidence, loss aversion and irrational investor behavior: A conceptual map’. Journal of Economic & Management Perspectives, 11(1), pp.273-290. Web.
Lebelle, M., Lajili Jarjir, S. and Sassi, S., (2020) ‘Corporate green bond issuances: An international evidence’. Journal of Risk and Financial Management, 13(2), p.25. Web.
Sharma, A.J., (2016) ‘Role of Behavioural Finance in the Financial Market’. International Journal of Business and Management Invention, 5(1), pp.1-5. Web.