FINANCIAL CRISIS OF 2007-2008 AND EMH

  100% Pass and No Plagiarism Guaranteed

FINANCIAL CRISIS OF 2007-2008 AND EMH

FINANCIAL CRISIS OF 2007-2008 AND EMH

The 2008-2009 financial crisis has spawned critics with investment theories bearing much blunt. Specifically, the efficient market theory has been singled out as the main cause of the crises. The theory holds that competitive financial market exploits all the available information to set the security prices (Chen et al., 2012). The theory is based on two tenets, that is, public information is reflected in the security prices immediately and that it is impossible to earn more than average returns without taking an above average risk. In the USA between 2000 and 2002 NASDAQ declined by 70% but for only twelve months, between March 2008 and March 2009, the index declined by about 50%. This raises the question as to whether the stock reflected all the relevant market information during between March 2008 and March 2008 in line with the efficient market theory and whether firms such as the Bear Stearns and the Lehman Brothers were making rational evaluation of the mortgage-backed securities included in their portfolio before the financial crisis that led the firms into liquidation.

The global financial crisis sparked a renewed criticism to the EMH where it was deemed responsible for the crises by making the financial leaders underestimate the breaking of the asset bubble. As the efficient market, the global financial market was supposed to get a new equilibrium after absorbing all the information. On the contrary, the market could not predict the extent to which the asset bubble was to affect it and in the process, the investors and market leaders could not make any move to prevent the crises. The rational expectation of the market to be efficient which was far from the reality. Based on the notion of market efficiency, the market regulators allowed the financial market to be resilient where it could absorb the shock and self-heal and by so doing they worsened the situation in the global financial arena. Chen et al., (2012) noted that by failing to give direction, and the failure of the financial market to self-correct indicates the unreliability of the concept of the market efficiency as advocated by EMH. However, Ball (2013) observed that the fact that the market reacts to all the available information cannot be ruled out given that during the 2008-2008 financial……………………