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Running Head: MANAGEMENT OF INVESTMENT PORTFOLIO
MANAGEMENT OF INVESTMENT PORTFOLIO
Name of the Student
Name of the University
1 MANA ...
Running Head: MANAGEMENT OF INVESTMENT PORTFOLIO
MANAGEMENT OF INVESTMENT PORTFOLIO
Name of the Student
Name of the University
1 MANAGEMENT OF INVESTMENT PORTFOLIO
Table of Contents
Introduction ................................................................................................................................ 2
Discussion .................................................................................................................................. 2
Co-Existence of EMH and Behavioral Finance to Explain the Stock Market Patterns ......... 2
Conclusion .................................................................................................................................. 7
Reference .................................................................................................................................... 8
2 MANAGEMENT OF INVESTMENT PORTFOLIO
Investment portfolio management is referred to as the analysis of different
opportunities of investment, formation, and selection of the most suitable blend of investment
to fulfill the objective, evaluation, and revision of the portfolio of investment from time to
time, and implementation of the changes required. It is an art of managing and putting
together different investments for meeting the specific goals. Different options of investment
have different levels of risk, and yields separate returns in the different periods. For making
most of the ones ’investment portfolio, the investors are required to actively participate in the
portfolio management. It is by doing so, they will not only be able to cushion the resources
against the risks of market but also able to successfully maximize their returns. The main
objective of the portfolio management is helping to select the best options of investment as
per one ’stime horizon, risk appetite, age, and income (Chandra 2017). Hence, this paper
aims to discuss and analyze “can EMH and behavioral finance co-exist to discuss the patterns
of stock return.
Co-Existence of EMH and Behavioral Finance to Explain the Stock Market Patterns
The study and field of finance has been long based on an idea of efficient market. It is
the term, which may imply different things to the different people; however, EMH that is
build upon the classical finance theory, assert that at any point of time, the securities and
assets ’prices being traded is correct and they reflect all the available information. Further,
EMH also constitute the one price law that implies that at any point of time, there is one only
price for the asset. EMH is the hypothesis, which assumes that the shares prices reflect all the
information and consistent generation of alpha is not possible. It assumes that on the
exchanges, stocks use to trade at their fair value, which makes it quite impossible for the
investors to sell or purchase the undervalued stocks for the inflated prices. Hence, it must be
3 MANAGEMENT OF INVESTMENT PORTFOLIO
not possible to outperform the complete market by the expert stock selection or market timing,
and only way the investor can get higher returns from the stock is by purchasing the riskier
investments (Kyriazis 2019).
EMH advocates that the prices of security quickly adjust to the new information. The
technical analysis is based upon an assumption that the new information to the stock market
is dispersed in stages to the huge base of investors. Further, the new information is passed to
the informed professionals, then it is passed to the aggressive investors, and lastly to all
general investors. Hence, the technical analyst assumes that the investors usually take much
time in analyzing the information. These experts believes that the stock ’s prices move
towards the new equilibrium after the new information announcement in aslow manner that
results in the stock price movement trends that continue over the time period (Mushinada
2020). Therefore, the view of EMH contradicts the assumptions of technical analysis directly.
If the capital markets are in its weak efficient form, prices completely reflect all the historical
information regarding the stock. Moreover, in this case, by the time the information becomes
publicly available, the price adjustment would have already taken place and the technical
trading system on the basis of the past data of trading would be having no value. This means
that the technical analysis is not at all valid. Further, the information that is available from
analyzing the prices of past has already been incorporated in the stock prices. Hence, investor
will be not able to earn any extra return (Ramiah, Xu and Moosa 2015).
The fundamental analysis purposes to know that the intrinsic value of firms is crucial
for getting superior risk-adjusted returns. Therefore, itis relevant for the analysts to know the
main variables that are relevant for the valuation process. EMH assert that the fundamental
analysis is also afailure. The analyst ’srecommendation based upon the publicly available
earnings as well as the other entity information is not expected to be much more precise
compared to those of the analysts of competitor. It is quite tough for the analysts to get the
4 MANAGEMENT OF INVESTMENT PORTFOLIO
exceptional insights that assist them to predict evaluation the entity ’s prospects with the
competitive edge. Hence, instead of the active portfolio management, the EMH advocates the
passive investment strategy. The passive investment strategy is based upon the buy and hold
strategy, such as creating index fund that replicates the broad-based stock index ’s
performance (Kumar and Nandamohan 2018).
The basic idea gives an idea that as there must be no such way that the causal investor
or a beginner investor, will invest and trade ever at the same level of rationality as a
professional trader for the investment bank. The traditional theory posits that the smart
investor, or the investors with the high knowledge level regarding the financial markets, will
try to counter the noise that is caused by all those, who are irrationally trading through the
arbitrage (Al-Khazali and Mirzaei 2017). Nevertheless, over the last few years, there has been
increased evidence against the complete arbitrage idea. During 1980s, the finance theorists
started considering the idea that the laws of investment were not as much clean as they had
theorized primarily. As the computers are becoming much more powerful, it has become
possible for analyzing the extensive data to prove all these opinions true. Hence, anew field
in finance has emerged from the limitations of the traditional finance theory, which was
named as behavioral finance (Tiwari, Albulescu and Yoon 2017).
Since years, the EMH has been one of the most dominant theories, which assumes
that it is unlikely to beat the market due to the fact that the entities use to trade at their fair
value, which makes it quite impossible to sell or buy the undervalued stocks at the inflated
prices. On the other hand, behavioral finance developed later for challenging this particular
concept by pointing out that the investors are not always rational, and the stocks did not
always trade at their fair value during the financial crashes, crises, and bubbles. In this field,
the economists attempt to describe the stock market anomalies through the psychology-based
theories (Pal 2016).
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Most of the economists have emphasized the behavioral and psychological elements
of the determining the stock price, and assume that the stock ’sprices are somewhat more
predictable based on the past patterns of the stock price and certain fundamental metrics of
valuation. Many of these economists made far more controversial assertion that these patterns
allow the investors to earn the more risk-adjusted rates of return (Urquhart and McGroarty
2014). Behavioral finance is the study of the investor ‘sbehavior of market, which stems
from the psychological decision making for explaining why the people use to sell or buy the
stocks. This is related to the behavioral cognitive psychology that studies the financial market
economies and the human decision making. Further, itfocuses upon the way investors act and
interprets on the information for making the informed decisions of investment. The investors
do not always behave predictable, unbiassed, and rational manner. The behavioral finance
places the emphasis upon the investor ’sbehavior that leads towards different anomalies of
market (Ndubuisi and Okere 2018).
The most common cognitive heuristics or the motives that explain the way behavioral
finance leads towards irrational behavior are stated below:
Representativeness :This occurs where people try to fit an unknown and new event into the
existing one; hence, discovering the common elements in entirely different type of events.
Anchoring :It is the cognitive heuristic that comprises the decision-making based upon the
initial anchor. Further, in various circumstances, people tend to make the estimates by
initiating from the initial value, which is adjusted to yield the final answer (Pal 2015).
Overconfidence :It is referred as the tendency of people to overestimate their abilities or
skills, which is to be too much confident of their knowledge, abilities, as well as the received
information, and as an outcome, to make the incorrect investment options. This also means
the egotistical attitude of people towards the stock markets.
6 MANAGEMENT OF INVESTMENT PORTFOLIO
Loss Aversion :It implies the peoples ’tendency of being risk averse for the losses compared
Mental Accounting :It is aset of the cognitive operations that are households and individuals
use to evaluate, organize, as well as keep track of the financial services. It involves tendency
of people to generate, depending upon their different mental aspects, special traits, and
register the events that they have experienced (Shahid, Coronado and Sattar 2019).
Regret Aversion :This comprises the investors ’desire to avoid the pain experienced by the
poor investment decision and as an outcome to postpone the stocks ’selling so as not to bear
Herding :In this, the individuals sense the requirement to join in the groups, and as an
outcome, develop aherd behavior in the situations of decision making (Chu, Zhang and Chan
The behavioral finance studies claims that rationality of the human decision making
must not be blindly followed instead of rejecting all the traditional assumptions. Hence, it is
believed that the psychologic and cognitive sides must be investigated while analyzing the
human decision making. Further, there is no any doubt that the investors are influenced by
the cognitive and psychologic aspects. While the behavioral finance is having popularity in
the financial environment, it is having no long history. Moreover, it is quite obvious that the
behavioral finance has different assumptions and models; however, itcan be accepted only as
anew dimension and suggestion. The behavioral science requires number of studies for being
accepted as avaluable theory (Tuyon 2018).
The approaches served by EMH and behavioral finance serves same purpose despite
of the fact that they posses ’different assumptions. Hence, assumptions of both should be
together used for understanding the investors and market. It can be said that understanding
7 MANAGEMENT OF INVESTMENT PORTFOLIO
the investors and markets will help in creating ground, which can assist market to be strong
against the economic crisis (Urquhart 2017).
Therefore, it can be concluded that both behavioral finance and efficient market
hypothesis coexist. They both are right for all the practical purposes. Both of the conflicting
views are the means to explain the market behavior and the investor. This implies that the
rationality and the irrationality co-exist, applying the principles of behavior and evolution to
the financial connections. It has been analyzed that the EMH and behavioral finance have
different kinds of the perceptions. While EMH asserts that people are the rational investors
who constitute significant part of the financial market. The behavioral finance that is the
alternative model that accepts the fact that the people are irrational and normal. When EMH
is considered, the main assumption is that the prices of stock market will reach at the
equilibrium since the prices are informationally efficient. Comparatively, behavioral finance
assumes that the investors are having the tendency to have some emotional and psychological
biases that lead towards irrationality. Hence, it can be said that both old and new concepts
attempt to find the solution for financial and economic problems. The assumptions of these
two models play significant role in understanding and preventing the financial crises.
8 MANAGEMENT OF INVESTMENT PORTFOLIO
Al-Khazali, O. and Mirzaei, A., 2017. Stock market anomalies, market efficiency and the
adaptive market hypothesis: Evidence from Islamic stock indices. Journal of International
Financial Markets, Institutions and Money ,51 ,pp.190-208.
Chandra, P., 2017. Investment analysis and portfolio management .McGraw-hill education.
Chu, J., Zhang, Y. and Chan, S., 2019. The adaptive market hypothesis in the high frequency
cryptocurrency market. International Review of Financial Analysis ,64 ,pp.221-231.
Kumar, S.S. and Nandamohan, V., 2018. Dynamics of randomness and efficiency in the
Indian stock markets. International Journal of Financial Markets and Derivatives ,6(4),
Kyriazis, N.A., 2019. A survey on efficiency and profitable trading opportunities in
cryptocurrency markets. Journal of Risk and Financial Management ,12 (2), p.67.
Mushinada, V.N.C., 2020. How do investors behave in the context of a market crash?
Evidence from India. International Journal of Emerging Markets .
Ndubuisi, P. and Okere, K., 2018. Stock Returns Predictability and the Adaptive Market
Hypothesis in Emerging Markets: Evidence from the Nigerian Capital Market.(1986-
2016). Asian Journal of Economic Modelling ,6(2), pp.147-156.
Pal, M., 2015. Reversion Diversion Hypothesis. Available at SSRN 2690677 .
Pal, M., 2016. Adaptive market hypothesis (study of assumptions). Available at SSRN
Ramiah, V., Xu, X. and Moosa, I.A., 2015. Neoclassical finance, behavioral finance and
noise traders: A review and assessment of the literature. International Review of Financial
Analysis ,41 ,pp.89-100.
9 MANAGEMENT OF INVESTMENT PORTFOLIO
Shahid, M.N., Coronado, S. and Sattar, A., 2019. Stock market behaviour: efficient or
adaptive? Evidence from the Pakistan Stock Exchange. Afro-Asian Journal of Finance and
Accounting ,9(2), pp.167-192.
Tiwari, A.K., Albulescu, C.T. and Yoon, S.M., 2017. A multifractal detrended fluctuation
analysis of financial market efficiency: Comparison using Dow Jones sector ETF
indices. Physica A: Statistical Mechanics and its Applications ,483 ,pp.182-192.
Tuyon, J., 2018. Role Of Behavioural Factors In Asset Pricing: Psychoanalysis Perspective
And Evidence From Malaysia (Doctoral dissertation, Universiti Sains Malaysia).
Urquhart, A. and McGroarty, F., 2014. Calendar effects, market conditions and the Adaptive
Market Hypothesis: Evidence from long-run US data. International Review of Financial
Analysis ,35 ,pp.154-166.
Urquhart, A., 2017. How predictable are precious metal returns?. The european journal of
finance ,23 (14), pp.1390-1413.
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