3. fficient securities market theory has long been under attack from behavioural

Question

3. fficient securities market theory has long been under attack from behavioural fnange Jwhich draws on psychological theories of investor behaviour to explain why secun do not always behave as the economic theories of predict. These attacks have increased following the 2007-2008 security market meltdowns Required a. Give two reasons why prospect theory predicts that security prices will differ from their ational investing and market efficency b. Describe two accounting-related efficient securities market anomalies and, for each, c. The efficient securities market anomalies suggest that investors underreact to the prices under efficient security markets theory explain why it is an anomaly. information content of financial statements. Identify two behavioural charactersto fu that predict this underreaction and, for each, explain why it predicts underreacton dedine d. Should accountants be concerned that the importance of financial reporting may if behaviourally biased investors do not use all the information in the financial state

Explanation / Answer

A)

Information availability: Efficient Security Market Theory [ESMT] is based on the premise that public information [to which ever investor has access to] is readily reflected in the security price on daily basis and the price change in the security on daily basis is mutually exclusive. However, in contrast to this hypothesis, Prospect Theory [PT] postulates that not every investor [due to difference in lifestyle, globalization, investing style, investing method] has access to the same information. In some cases, a class of investor might have more/less information compared to other investors, and hence the difference in the securities prices.

Treatment of Investors: ESMT assumes that every class of investor involved the stock market is uniform sharing similar investing style, interests, behaviour, expectation. However, as per PT, the investors don’t belong to the same class. Different investor groups may have different ideologies, compulsions, investing styles, gestation periods, culture that in turn render efficient markets as ideal.

B)

C)

2. Different investors have different tax compulsions, gestation periods, and investing styles

D)

Accountants should publish the information accurately as prescribed by the Management of the company following the guidelines of the relevant regulatory authority. Investors can use the financial statements as per their discretion in calculating a wide variety of ratios to arrive at the security price based on the future earnings. Also, to arrive any security calculation the siginifcance of financial reporting of a company cannot be understated as it forms the basis for security price calculation.

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