Efficient Market Theory as it

¶ … efficient market theory as it relates to market performance. On page 2, the article provides evidence that suggests the efficient market theory is flawed in many respects (Frank, 2008). For one, as new model and approaches are developed, the initial benefit is soon eroded as new market participants begin to the use the model. The initial advantage of knowledge and information is subsequently eroded as market participants, attempting to outperform the market, utilized similar techniques. With more investors using similar techniques the gains are eliminated until a new model is discovered.

The efficient markets theory is predicated on the continuous flow of information to market participants. In the event that adverse news affecting a business enters the market, the price of the underlying asset quickly adjusts to reflect the news. What I believe researches are neglecting to mention in regards to this theory is the emotional component involved in making financial decisions. Many of the prevailing theories such as CAPM assume efficient markets and rationale participants within those respective markets (Frank, 2008). However, market participants are anything but rational.

This occurs particularly during investment periods characterized with extreme bouts of pessimism. Generally the market overshoots in their valuations particular with overly optimistic and pessimistic forecasts. As such value investors achieve high rates of return by capitalizing on this emotional folly. As such the efficient markets theory and CAPM are rendered null and void as the many value oriented investors continue to outperform the market. Financial Economic Theories On page 3 of the article, the Frank discusses CAPM as it relates to theoretical study.

The principle concept of CAPM is that through quantitative analysis a fund manager can eliminate the portfolio risk. The manager however, will still need to contend with systemic risk inherent within the market itself. Under this principle, an investor can compare the rate of return calculated by CAPM with that of the markets to determine if the investment will be profitable over the long-term (Frank, 2008). As the article states, on page 3 however, both CAPM and regression analysis are predicated in an ideal world with rational investors.

CAPM has had very little success in regards to real world application. This is indicated on the overall performance of quant managers located on page 4 of the article. On page 4, Frank discusses the implications of a large inflow of capital on the returns of CAPM and quant managers overall (Frank, 2008). For one, as the article indicates, the fund manager would have to adjust the portfolio holdings constantly to diversify all the portfolio risk imbedded in his investments.

As asset prices change constantly throughout the day, it will alter the portfolio manager's strategy under the CAPM model. This results in the subpar performance experienced by quant managers due to transactions cost and capital gains taxes. Furthermore the non-liner interactions with agents make the reliability of regression analysis questionable as well. In addition, page 4 of the article indicates that differing market sentiments regarding quant managers (Frank, 2008). As the article indicates, value investing is favored during periods of mass pessimism.

However, when markets are optimistic, quant fund managers are preferred by overall investors. As page 4 of the article indicates, quants are underperforming due to the mass use of data to make overall investing results. Furthermore, data is now easily manipulated so it difficult for fund managers to delineate between quality data. On page 7 of the article, Frank discusses the concept of reversion to the mean. Reversion to the meal has very profound impact on the performance of all fund managers alike (Frank, 2008).

It is customary in the financial markets to "chase performance." Typically, the fund with superior returns attracts large amounts of capital. As a result, the.