(R)Evolution of Financial Theory

Abstract:     
How can we explain that in 2008/2009 the global stock markets plummeted –50% in nine months only to rebound by 60% over the following nine months? Why did investors price in the future earnings of the global stock market at 35 times the market price at the height of the TMT bubble, while the same multiple reached a low of 10 in March 2009? Can these swings be reconciled with the theory of the rational investor or are the global stock market and its participants irrational? Market participants and academics alike have struggled with finding answers to such questions. Over the years numerous potential explanations have been propagated. In this white paper we attempt to disentangle the most prevalent theories used to account for the ups and downs on the global stock market. Which theories (or maybe rather ideas) are most commonly brought forward, what is their core message, and which practical implications do they entail for the investment community? And last, but crucially, do any of these theories stand the test of reality?

Number of Pages in PDF File: 7

Keywords: Financial theory, efficient market hypothesis, behavioural finance, adaptive market hypothesis, theory of rational beliefs, pricing model uncertainty

JEL Classification: A00, A10, A20

working papers series