Behavioral finance FAQ / Glossary (Anomaly)
This is a separate page of the A section of the Glossary
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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed, i: incidental |
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01/5i - 02/7i - 04/2i,5d,6i - 05/5i,6i + see behavioral biases, price anomaly, EMH, inefficiency, collective bias, fair value, asymmetry. |
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Typically, such a discrepancy contradicts the EMH / Efficient Market Hypothesis (see that phrase). (*) Also called inefficiency (see that word) or imperfection, or
or also, as a more neutral and factual world, effect (see also that word). That last appellation tries not to give opinion on how weird either the phenomenon or the paradigm might be. (**) Anomalous price rises or falls translate into anomalous (negative or positive) returns. The main component of an asset return is its price change (except maybe for bonds or, in some degree, for real estate).
Unrealistic ...realities? Or abnormal ...norms? There is a paradox in qualifying real situations as anomalous, and even more if those purported anomalies are frequent. That ambiguity might come from the criteria used.
In financial asset markets, the usual reference is the EMH / Efficient market hypothesis-based models (see "efficient market hypothesis").
Another common reference (closely related to the EMH) is the
It states that things evolves according to a normal random distribution law (see distribution). The flaw is that, in economics and finance, evolutions do not fully follow such laws. This is shown in data clusters, fat tails, asymmetries, percolation thresholds, cumulative bifurcations and other phenomena explained in this glossary.
if we take that random hypothesis as fully valid.
Can they help you
evidences of financial anomalies and find a use for them? Anyway, in reality, anomalies, unless blatant, are
hard to define, to spot and to
This is because the theoretical models used as references (**) might be themselves ...anomalous, at least partially. (*) And therefore hard to be used for one's advantage! They do not always help to detect anomalies with certainty so as not to invest in overpriced assets (see overpricing). It is even less easy to correct them to find what is the "true" value (**) Even behavioral finance refers to the EMH instead or looking for its own valuation theory (with a few exceptions: see "behavioral pricing"). This can be considered as one of weaknesses of BF in its present state.  Are return and price anomalies common or rare? Temporary
 or persistent?
Just occasional market gaffes? Or the ordinary and repetitive market way of life? The idea behind the word "anomaly" is that the famous "invisible hand" suffers occasional clumsiness. But the question arises about those purported gaffes: Occasional? Or common and recurrent? 1) Occasional anomalies (short term anomalies) In some periods, or in some types of assets, anomalies are rare and/or get automatically and quickly corrected, as soon as some traders see an opportunity of
Those mild and transient discrepancies do not contradict fundamentally the EMH paradigm behind the model. They also fit what most of those models consider as simple "volatility" (see that word). without much explanation about its origin, 2) Persistent anomalies (long term anomalies) Some anomalies are recurrent and / or persistent, or are corrected in ...anomalous ways.
Thus, the EMH might be a theory that only describes idealized, nearly never reached, cases. If total efficiency / inefficiency happens only in borderline cases, we should talk about "degrees
In that case, the EMH is a tentative approximation that reflects and explains the market only in some degree.
Officer, what was wrong? The map? The car? The driver? Anomalies, defined again as market deviations from standard theoretical value, seem to have three main causes
Clogged pipes In general, nearly all markets are imperfect, with minor or big built in obstacles that prevent a "perfect competition".
But some markets, get nearer that blissful state than others. * Organized financial assets markets, the big stock exchanges for example, are said to be closer to perfect competition than other economic markets. * The main commodity markets are also considered as such. But even so, all those markets have some structural imperfections.
Blind crowds One or a few person's behavioral biases cannot really change the market course.
Those behavioral biases (see that phrase), whether cognitive or emotional, individual or collective, are the bread and butter of this glossary. Herding is the most typical of those collective biases that distort market prices.
in the standard market theories used as the comparison basis. Kids in the lab
or whatever cognitive bias. Yes, models themselves might be built on cognitive biases. See "model". |
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financial market
anomaly (*) is
diverges from some standard paradigm.
distortion
models
optimal allocation of resources.
RWH / Random walk hypothesis .
detect, on the market crime scene,
measure (*).
"arbitrage" (see that word).
(uptrends, downtrends), which durability raises
extreme price evolutions (bubbles, crashes), showing exaggeration
, on the other hand,
of efficiency". 
:
1) Imperfect market structures.
2) Collective / contagious behavioral biases.
3) Not to be neglected, oversimplifications(*) To find those messages: reach that Behavioral-Finance group and, once you are there, 1) click "messages", 2) enter your query in "search archives".
Members of the Behavioral Finance Group, please vote on the glossary quality at Behavioral-Finance/polls
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This page last update:
16/11/11
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