There are two primary theories of investing: the efficient market hypothesis (EMH) and the behavioral finance view. They are primarily mutually exclusive concepts and color investors' views of how much they can impact investment returns.

The EMH indicates that all past, present, and anticipated information is already factored in the prices of stock. Hence, it is very difficult to outperform the market. Thus, it would be prudent to just invest in market indexes such as the S&P 500 index. Warren Buffetts mentor, famed financial pioneer Benjamin Graham, introduced the concept of the erratic Mr. Market, which is the stock market. Mr. Market is always there to buy and sell, but his prices are not necessary instructive or reflect real values. Behavioral finance models indicate that Mr. Market is unstable; thus, the markets can get too enthusiastic and bubbles can occur on the upside.

On the downside, Mr. Market can overreact to bad news, which can result in market crashes. If investors can stay unemotional, they could take advantage of Mr. Market and buy during depressed times and sell during inflated times.

These concepts are not only important in corporate finance with institutional investors but in personal finance for individual investors. There is compelling empirical evidence on both sides of the argument, and it will be wise to see both sides of the coin.

After reading about the two schools of thought, which do you personally believe in: the EMH or behavioral finance? Explain why, and give examples to justify your response.

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I can provide insight into both schools of thought The Efficient Market Hypothesis EMH posits that f... View the full answer