When the market becomes inefficient: Comparing BRIC markets with markets in the USA
A rational investor will believe that an efficient market today will remain efficient tomorrow. However, when emotions take over, markets are no longer efficient. Further, they may remain so for longer anyone can forecast. Evidence of such inefficiencies is prominent in large emerging markets in Brazil, Russia, India and China and also in developed markets in the USA. When a market is inefficient and sentiments play a dominant role in an investor's decision making, valuation by any existing asset pricing model would produce a suboptimal risk–return relationship. Standard pricing technology will guide a rational investor to wrong policies for his new investments or for reallocating his old investments. In an alternative approach, we have worked out a model which incorporates market sentiments in the domain of the standard rational model of asset pricing. Our model is applicable for a ‘less than’ efficient market and, therefore, may be a useful input in investors' toolkits.
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