The Quotes of Fama & Buffet about Market Efficiency and Behavioral Finance
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The Quotes of Fama & Buffet about Market Efficiency and Behavioral Finance Introduction
In this era of development and competency, every field has been evolved. However, due to the competition in every market, it is necessary to realize the ups and downs of the related industry and market, so that all the clashes and losses are avoided. Consequently, market efficiency and behavioral finance influence performance. The term market efficiency refers to the extent to which the prices of markets reflect the relevant available information. This term helps to analyze the investors that they cannot outperform because of the market anomalies. Additionally, the term behavioral finance enables to analyze the market anomalies, for instance, the rise or fall in the stock price. Being a researcher at an actively managed equity fund it can be helpful to analyze these facts in the context of market efficiency and behavioral finance. In this regard, this essay is proposed to highlight these concepts by referring to the sayings of Fama and Buffett.
Discussion
This essay aims to give a critical analysis by evaluating the quotes of Fama and Buffett and the implications of these for the funding. However, the modern area of financial study can be a better understanding by exploring the efficient market hypothesis, market anomalies, and behavioral finance. The theory about the market hypothesis is most crucial in the study of finance. This theory was proposed by Eugene Fama after the mid of the 19th century. This theory is revised and has been tested for decades. However, one of its quotes is also discussed below.
The term market efficiency enables to measure the capabilities of the market to incorporate information. However, this provides the maximum number of chances to both sellers and purchasers of securities so that effective transactions can be made without the increase in transaction costs. Another important term is behavioral finance and it is also considered as a subfield of behavioral economics. It comprises of psychology based theories that explain the details of the stock market. In terms of behavioral finance, it can be realized that the decision of investment made by any individual and the market outcome influence due to the characteristic of the market participants and information structure as well.
Discussion of Fama’s Views
The widely known and accepted Efficient Market Hypothesis was pioneered the way by Eugene Fama. He stated that the markets are efficient on the basis of quantity and quality of information exposed by the corporations. Furthermore, he said that markets are of three types depending upon the prices at any point which fully reflects the information available. One of the strongest points is that all the information is available for the investors and this can eliminate the rate of abnormal earnings. However, a semi-strong point is that prices also reflect the accessible information. On the other hand, the weakest point implies that, although prices reflect the information only the historical (Pinto and Asnani, 2011).
Fama was from the University of Chicago and his work helped a lot in developing the modern theory which defines the working of the stock market. The existing literature reveals that he introduced the three factor model that aided in figuring out about, how much return can be achieved by Stocks. The existing reports about Fama help to explore a little about his personality as Fama can be brutally honest. However, his quotes are very helpful and informative as he reveals that a noise surrounding a manager’s performance that it becomes difficult for the manager but it is not impossible if someone can distinguish the luck and skills. Due to his performance, he has also rewarded the noble prize.
The Eugene Fama’s quote is worth reading “After costs, only the top 3% of managers produce a return that indicates they have sufficient skill to just cover their costs, which means that going forward, and despite extraordinary past returns, even the top performers are expected to be only as good as a low-cost passive index fund. The other 97% can be expected to do worse” (Fama, 1998). These lines can also guide me while being a researcher because good money can be made by the assessment of personal performance. Fama's quotes are capable to dismiss the financial crisis by avoiding the big recession as it is the trigger of crisis in the market.
Discussion of Warren Buffett‘s Views
After reviewing the existing literature, it can be added that Warren Buffett a Fund manager holds a fascinated personality. However, the Buffett reigns and regarded as the greatest investor of the history. Furthermore, it is also realized that he is a gentleman who never worried about the making of money but he states that everyone should do best in whatever one can take on. Besides, the other charming quotes of Buffett one of his quotes sound to be concluded incorrectly. As he said “I’d be a bum on the street with a tin cup if markets were always efficient” (Buffet, 2016). On the other hand, if things are observed practically it can be realized that markets are frequently efficient. However, the success behind the Buffet is somewhere hidden behind this ambiguous quote.
In addition to this, by exploring the practical examples that can support the argument of Warren Buffet it is realized that the stock prices always decline before the concerned people came to know about that what is happening. However, the example of the declination of Lehman's stock prices can be considered as the people were unaware of the value of the company's assets. Afterward, Lehman blamed the government and then he tried to buy supreme loans. However, this scenario is accurately answered by Warren Buffett in the shape of the quote mentioned above. Warren Buffett is the third richest man in the world.
Conclusion on Market Efficiency and Recommendations for the Fund
By the time revolutions have been observed in the market efficiency and funding strategies. Moreover, it is also noticeable that the efficient market revolution and its intellectual dominance have been challenged more by economists. This is due to the reason that those economists used to stress the psychological and behavioral components related to the stock price determination. Moreover, some econometricians believe that stock returns are predictable by the available information. In addition to this, an important factor that is realized by reviewing literature is that today's stock markets are efficient than before and is less predictable as it is not defined in the various theories and quotes. Thus, for this reason, the quotes of Buffett and Fama seem to be critical in the context of funding.
On the basis of the idea that our markets are less predictable and are more efficient, it can be added that whatever the behavior of stock prices is no investor can earn unexpected risk adjustment returns. However, it is also analyzed that efficient markets are do not allow the earning above-average returns to the investors, without the acceptance of above average risks (Pinto and Asnani, 2011). Let us analyze the efficient market by an example of a student and a teacher which is mostly quoted. For instance, a 100 $ bill falls or lies on the floor and when the student tries to pick it up the teacher says, please bother not because if it is a 100$ bill then it would not lie there on the ground. This story helps to analyze the scenario when an economist says markets are efficient.
Moreover, if the market's participants become quite irrational then the market can be efficient too. In addition to this, markets can also be efficient in a sense if greater volatility is exhibited by stock prices. However, the fundamentals such as dividends and earnings can help to explain the market efficiency in the context of stock prices. There is no doubt that by the passage of time due to sophisticated databases and empirical techniques market efficiency can be obtained and it can result in development in the patterns of stock return.
While being a researcher it is a foremost duty to analyze the relationship between the market efficiency and equity funds. An equity fund is often called as the mutual fund because this is invested principally in the stock market. However, actively or passively it is the managed, Index fund. In other terminology, equity funds are also known as stock funds. These funds are principally categorized according to the nature of investment style, company's size and geography (Pinto and Asnani, 2011). After the critical and detailed analysis of Fama and Buffett’s quotes, it can be added that the financial markets are mostly semi-strong efficient. Moreover, it describes that unlikely to consistently the investors cannot beat the market from last year to the coming year.
However, in terms of mutual funding, diversification seems to be a good thing. This means that by the addition of more and more stocks to the portfolio the risk associated with the specific events of the company can be eliminated. Moreover, only systematic risks can be then left which is about the risk financial markets compensation that is bearable. In addition to this evidence in the support of semi-strong efficient market is realized that efficiency can be brought if the stock prices can respond according to corporate’s announcements.
While funding according to equity funds a diverse portfolio of stocks is needed to manage. This is because as the funds after fee rises and falls the value of investment rises and falls accordingly. However, the purchasing of shares the size of the portfolio can be increased by an open-end mutual fund. This can be further explained as the purchase of shares in a mutual fund probably cheaper than the making of individual stocks and bonds by a diverse portfolio. Additionally, no solid evidence is found that mutual fund managers can insistently beat the market. Moreover, the managers charging the high fees can insistently underperform the market and strong evidence is also found about that.
As it is claimed in the efficient market hypothesis that is past and future returns are not correlated then the market will be efficient in a weaker form. In clear words, it claims to distribute identically and independently. Thus, the quote of Fama is related to the idea of a random walk model. Moreover, there exists a difference between the Fama's literature and his model leads to the weak form of efficient market hypothesis but not vice versa.
While recommending for the funds it is necessary to analyze the difference between the actively managed equity funds and passively managed equity funds. As they both are different. However, better analyzation can help a manager to invest funds in a better way. I am actively managed investment funding the decision is made by the manager or by the management team about the investment of Fund’s money. Whereas, in the passively managed funding it is opposite to the actively managed funding. This is because in passively managed funding a market index is simply followed (Pinto and Asnani, 2011). No funding management team can make decisions about the investment. Besides the analysis of all the critical things about the efficient market in the discussion above, one must invest funds according to the nature and type of funding.
It is a matter of fact that there exist some pros and cons of each type but to critically analyze the active funds, it is found that active funds can make it possible so that market index can be beaten. Additionally, the existing examples like Fidelity's Magellan Fund reveal that active funds can return huge returns. One of the disadvantages realized is that sometimes actively managed funds do underperform as compared to passive ones. However, these risks can be avoided by analyzing the available information available about the stock and market. Moreover, the category of the market also matters. So before any type of decision in an actively managed funding, one must acknowledge the efficiency of the market as much as if it is possible to analyze.
References
Buffet, W. About Warren Buffet: quotes. The Warren Buffet Way. Available at: http://au. wiley. com/WileyCDA/Section/id-817935. html (accessed 28 July 2016).
Fama, E. F. (1998). Market efficiency, long-term returns, and behavioral finance. Journal of financial economics, 49(3), 283-306.
Pinto, M. V., & Asnani, K. (2011). Stock price prediction using quotes and financial news. International Journal of Soft Computing and Engineering (IJSCE), 1(5), 266-269.
