Most of the fundamental finance theories we studied so far based on the assumption that the market is efficient. But according to the behavioral theories, investors (especially the individual investors) do not behave rationally, focus on loss aversion instead of risk aversion, and do not focus on the aggregate portfolio but only consider individual investment individually. As a result, the market should be inefficient. Does it mean that we should not stick with those fundamental theories? Nowadays, there are Islamic bonds which cannot include stocks like winery and gambling. There are also people investing only in the environmental friendly stocks. More and more investors are not investing based on the fundamental economic values. Does it mean that the world’s market is becoming more and more inefficient? Or would you say as the financial market becomes bigger and bigger, it is also more dominated by institutional investors, who generally will invest rationally as described in our textbooks? And as the general public are better educated, individual investors will also be investing more rationally?
I think there the market is never efficient, but always tends towards a perceived efficient state which is itself constantly moving. Islamic investors avoiding wine stocks is what the book would call a chronic inefficiency- it won’t resolve itself to another state anytime soon so it doesn’t represent an investment opportunity.
I think Islamic investors avoinding wine is a really minor inefficiency compared to the inefficiencies created by massive government involvement in haphazard ways, a complete rethinking of structured finance, a billion and a half risks that can’t be funded but should be, crazy credit restrictions, interest rates that are negative to some borrowers, etc…
Add to it - structure of the markets - investment mandates (e.g. socially responsible funds, pension guidlines, inability to hold non-investment grade debt), psychological factors (spinoffs as an example of indifferent and motivated sellers), small to micro cap stocks - lack of coverage / attention leads to more inefficiencies, the list goes on Markets were never efficient - its just more inefficient now for obvious reasons