MODERN FINANCE THEORY: THEORETICAL BACKGROUND
In recent years, the majority of financial and economic theory has been based upon the idea that individuals’ actions are guided by rationality - that people make decisions in light of all the information available to them.
Andrikopoulos noted that the years between 1950 and 1960 were the most productive period in finance thought. This was the period in which finance changed from a descriptive discipline to a modern science full of new ideas that needed to be refined. Finance literature focused on exploiting the full potential of mathematical probabilistic and optimisation models. These techniques led to the construction of new theories and models, such as portfolio optimization theory, the capital asset pricing model, and the efficient markets hypothesis. These principles would constitute key influences in the years to come (Andrikopoulos, 2007, p. 53), during which empirical research focused on EMH testing and asset prices modelling.Among these financial theories, special interest was directed to EMH, which represents the cornerstone of standard academic finance to this day. Although EMH is an appealing description of competitive market equilibrium, it is difficult to follow the developments in financial economics of today’s global world in a single direction. This difficulty arises because schools of thought overlap, theories and empirical research are lagging, and technology has greatly changed the way academics think and do research (Buchanan & Bowman, 1995, p. 156). Within two decades ofthe introduction ofthese ideas, contradictory evidence from financial markets around the world began to emerge. The appearance of many anomalies led some academics to reconsider their initial beliefs about the applicability of the leading theories of modern finance. This was the beginning of a new era -- the era of behavioral finance. As the new ideas of behavioral finance were introduced, a rigorous academic debate commenced on the validity of these new theories.
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