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Example of Financial Illusion in 2000s

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Example of Financial Illusion

Introduction

The emergence of an increasing number of ‘financial illusions’ in the current state of financial markets around the world casts doubts over the famous and widely accepted efficient market hypothesis. The efficient market hypothesis (EMH) indicates that, at any time, prices fully and instantaneously reflect all available relevant information on a particular stock or market (Fama, 1970). EMH also suggests that it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. Thus, according to the EMH, it is impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices because stocks are always traded at their fair value on stock exchanges. Another reason is because no one has access to information that is not already available to everyone else. One important characteristic of the EMH is its assumption that agents are rational. Rational agents is agents which has a clear preferences, models uncertainty via expected values, and always chooses to perform the action that results in the optimal outcome from all the feasible actions. Their actions depend on their preferences, their information of the current situation; which may come from past experiences, the actions, duties and obligations available and the estimated or actual benefits that the agents can get after the actions. In reality, however, agents are not always rational; people’s decision does not always correspond to the concept of economic rationality. Most people, in fact, make their decision rather intuitively. This leads to an interesting new study of behavioural finance, a study that linked psychology with finance. It provides explanations to well-known market anomalies such as: the small firms outperform; in which the case...

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