Question

Find and explain a real-life scenario of financial irrationality, i.e., violation of efficient market hypothesis (EMH).

It can be from investors' irrationality, finance managers' irrationality or any irrationality related to finance.

Answer 1

There are many examples available for the markets being inefficient, even without any information asymmetry between the investors. Market inefficiencies come out very prominently in situations of crisis. And, there are some investors who make use of these for their benefit. There is also a saying by Mr. Warren Buffet which goes like this- "Be fearful when the market is greedy and greedy when the market is fearful." Here, we are discussing the latter part of his saying. The examples can be seen in any sort of crisis that have happened in the financial markets. For e.g. in the dot-com bubble, the investors were attaching high valuation multiples to any tech website and business. Basically, if your business had .com at the end of it, you will be amongst the top-gainers of the stock market. The market didn't value the businesses rationally and in the end everyone suffered. The opposite also happens in times of crisis. Many good companies with strong balance sheets suffer in valuation by markets because the peers of their industry or other big players in the market are performing poorly.