The aim of this report is to evaluate and validate passive investment strategies and advantages of having index funds in the portfolio. The importance of passive investment strategy is initially justified with the help of theory on efficient markets. The report then provides evidence that indexing still is a vital aspect of investment strategy and is not influenced by the efficient market theory. The report also gives a brief overview on how investors utilize indexing to minimize transaction cost by replicating the market index in their portfolio. Further, the success of indexing in US, UK and bond markets is highlighted with the help of evidence from past research on passive investment strategies. The later section of the report provides brief introduction of behavioral finance and how psychological biases affect investor’s behavior and prices. It also provides its contrasting viewpoint with respect to the Efficient Market Hypothesis (EMH) and analyzes the effects of mispricing on average returns achieved by investor.
Passive Management Strategy
The supporters of the efficient market hypothesis believe that active management is a largely wasted effort and does not support the expenses incurred due to the mispricing of stocks (Barberis and Thaler, 2003).Therefore, they advocate passive investment strategy that makes no possible attempt to beat the market. A passive strategy involves minimum input and instead relies on diversification of the portfolio in order to match the performance of the market index. Passive management is usually characterized by a buy-and-hold strategy because the efficient market theory indicates that stock prices are at fair levels, given all available information and it makes no sense in frequent buying a...
... middle of paper ...
...his fact is utilized by the investors to plot wining strategies. Furthermore, the evidence from this study suggests that it is not necessary to know predictable patterns and market inefficiency in order to implement profitable investing strategies. Taken together, these results suggest that investors are able to achieve higher returns and minimize transaction cost by adopting indexing strategy which mimics the market. The second major findings are the contrasting view of behavioral finance. Two decades ago, many financial economists supported the Efficient Market Hypothesis because of the forces of arbitrage. Today it can be realized that it was indeed a very naive view and the limits of arbitrage can result in substantial mispricing. Thus through this research it is understood that absence of profitable investment strategy does not infer the absence of mispricing.
Need Writing Help?
Get feedback on grammar, clarity, concision and logic instantly.Check your paper »
- The rationality of financial markets has been one of the most hotly contested issues in the history of modern financial economics. Recent critics of the Efficient Markets Hypothesis argue that investors are generally irrational, exhibiting a number of predictable and financially ruinous biases such as overconfidence, overreaction, loss aversion, herding, psychological accounting, miscalibration of probabilities, and regret. The sources of these irrationalities are often attributed to psychological factors – fear, greed, and other emotional responses to price fluctuations and dramatic changes in an investor’s wealth.... [tags: irrational, psychological, investment]
543 words (1.6 pages)
- The purpose of this paper is to evaluate how the growing Chinese presence in Kenya affects the United States’ international interests. In order to do this, we must look at how China was able to create such a presence, what the U.S. did or failed to do to alleviate this, Kenya’s view on both the U.S. and China, and if the U.S. would benefit from expanding or decreasing economic investments in the country. While the United States has a long-standing foothold on the oil in Africa, China has been dominating the other natural resources available for the past 20 years (Bhorat 2013).... [tags: Investment, China, Kenya, PRC]
874 words (2.5 pages)
- Introduction In macroeconomics, foreign direct investment has been defined as the direct investment made in a country by foreign individuals or corporate organizations. On a broader view, FDI refers to activities such as acquisitions and mergers, building of new facilities like factories and joint ventures. Zilibotti (2009) posits that there are three major forms of Foreign Direct Investment: Horizontal FDI where corporate investors duplicate the same activities in their home country in the country of investment, Platform FDI where the corporate invests in a country as a platform for exporting to another third country and vertical FDI where corporate investors downstream or upstream in a val... [tags: corporate, organization, country, investment]
1167 words (3.3 pages)
- Purchasing of a product or an item with an aim of profit generation via the purchased item can be viewed as investing and the item, an investment. Before purchase, an estimate of the potential market value of a financial asset or liability has to be determined, that is, analyzing the investment. The analysis has to take into consideration various issues such as the overall state of the economy, interest rates, competitive advantage and many others. The analysis can be technically or fundamentally carried out but financial forecast has to be considered (Tutor 2 U, 2011).... [tags: Investments]
949 words (2.7 pages)
- Risk Analysis on Investment Decision Silicon Arts, INC. (SAI) is a four year old company that manufactures digital imaging integrated Circuits (IC's) that are used in digital cameras, DVD players, computers, and medical and scientific instruments. Hal Eichner, SAI's Chairman, has a two-point agenda for the company to increase market share and keep pace with technology. As the Financial Analyst for the company one must analyze two mutually exclusive capital investment proposals. The two options are to expand the existing Digital Imaging market share or enter the Wireless Communication (W-Comm) market.... [tags: Investment Finance Analysis]
806 words (2.3 pages)
- Foreign trade Foreign trade is exchange of capital, goods, and services across international borders or territories. In most countries, it represents a significant share of gross domestic product (GDP). (http://www.yourarticlelibrary.com) It is a trade between two or more countries and we can separate into three parts. • Import- Affluent countries import resources and commodities when they find comparative advantages in sourcing from foreign locations. (Holt, Wigginton, 2002) • Export – involves selling domestically produced products in foreign market through brokers or overseas distribution centres.... [tags: foreign trade, direct investment, global economy]
879 words (2.5 pages)
- Investment Alternatives Benchmarking for Bernard Lester Whether it’s a strong competitive market or the effectiveness of shareholders maximizing shareholders wealth has become the norm for the global production market. Companies have found different operational strategies to convert less than profitable corporation into long-term profit maximizing corporation. Corporate CEO’s and financial manager must distinguish between growth or operational wealth, which will determine the possibilities of growth maximization, defining current and projected values to shareholder, examining growth opportunities, and increase market values.... [tags: Investment Alternatives Benchmarking Bernard Leste]
1979 words (5.7 pages)
- Foreign Direct Investment in Myanmar (Graphics not Included) Since 1962 the Burmese government has been under military rule (Country Profile, 2007). The lives of the Burmese citizen are dictated by the totalitarian style of government which led to horror and starvation, causing numerous protests against the government. The latest protest in 2007 was planned and organized by the same student groups which took part in the similar protest earlier in 1988. The first protest was held on 15 September 2007 with protesters protesting on streets in Yangon on nearly a daily basis.... [tags: FDI Foreign Direct Investment]
1969 words (5.6 pages)
- Portfolio Analysis and Investment This assignment is concerned with your understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the Cybrary, the Internet, and course resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices: . How individual investors make investment decisions in practice rather than in theory; and .... [tags: Investment Theory Brokers Essays]
987 words (2.8 pages)
- Introduction This report is going to be examining aspects of the Polish economy and its attractiveness for inward investment. I will be using a PEST analysis along with examples to illustrate why business is moving into Poland and the benefits they receive. Poland joined the European Union (EU) in 2004 after going through transition from communism to a market economy. It has several major industries including agriculture, heavy industry such as coal mining and work with iron and steel along with the production of other consumer goods.... [tags: Poland Economy Investment]
1505 words (4.3 pages)