Honors Theses and Capstones

Date of Award

Spring 2020

Project Type

Senior Honors Thesis

College or School

PAUL

Program or Major

Finance

First Advisor

Richard Kilbride

Abstract

The Efficient Market Hypothesis is a widely accepted economic theory developed by economist Eugene Fama. The theory states that at any given time, an asset’s price reflects all available public information and will always trade at fair value. The motivation for this research is derived from the content taught in undergraduate finance courses. In undergraduate academia finance students are introduced to the idea of market efficiency, as it is a building block for future theory and application. However, this theory is rarely questioned in the world of undergraduate academia, rather just taken as fact by students.

The underlying research in this paper attempts to answer a key question in the investment world of “are asset prices always right as stated in the EMH?”. If asset prices are always trading at fair value, individuals cannot achieve a return on investment that is higher than the market average, rendering active management useless.

This research has concluded that there are times where assets are not priced to fair value. This is not to say that the EMH is wrong, but rather ‘not right’ 100% of the time. Market inefficiency is driven by three main factors that will be mentioned in this paper: (1) Investor cognitive error (2) Market disruptions and illiquidity (3) Investor emotions (fear & greed). Throughout the paper there will be examples of both extremely efficient & inefficient market pricing.

This paper will prove useful for any finance student or recreational investor who has never challenged the EMH and is attempting to form their own opinion on market efficiency.

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