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ABSTRACT
The recent U.S. financial crisis, the U.S. stock market crash of 1987, and other recent anomalies have seriously challenged Fama's classic efficient capital markets hypothesis. These events have made it likely that future capital markets research will be enriched by the important role that human behavior plays in the success or failure of the financial markets. This paper examines the factors causing the recent crisis within the United States financial senices sector, the degree to which it may be explained by efficient capital markets theory and the degree to which such behavioral finance concepts as noise, excessive volatility, fashion and fads, and irrational behavior compromise that theory.
Keywords: Financial Crisis; Efficient Market Hypothesis; Behavioral Finance
INTRODUCTION
The financial crisis in the U.S. economy in the late summer and early fall of 2008 was so great that it largely overshadowed the presidential election campaign. Each day the media reported new evidence signaling the continuing decline of our financial markets and economy. For example, in a period of a few months beginning in early September 2008, the government-sponsored enterprises known as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) were placed in conservatorship; Lehman Brothers filed for bankruptcy; Bank of America acquired Merrill Lynch at a significant discount; the government intervened to help insurance giant American International Group (A.I.G.); The Washington Mutual Investment Fund was closed by the Federal Office of Thrift Supervision; Goldman Sachs and Morgan Stanley became bank holding companies; and Wells Fargo Bank eventually took over Wachovia Bank. These events, in addition to the earlier collapse of the IndyMac Bank and the takeover of the investment firm Bear Sterns by J. P. Morgan Chase, contributed to significant upheavals in the credit markets and directly reduced the availability of credit to banks, businesses, and average Americans. This paper examines the factors causing the recent crisis within the United States financial services sector, the degree to which it may be explained by efficient capital markets theory and the degree to which such behavioral finance concepts as noise, excessive volatility, fashion and fads, and irrational behavior compromise that theory.
WHAT CAUSED THE CRISIS?
Much of the initial deterioration can be attributed to the burst of the housing bubble which...