Evolving Market Efficiency and Its Implications

Open Access
Gress, David J
Area of Honors:
Bachelor of Science
Document Type:
Thesis Supervisors:
  • Brian Davis, Thesis Supervisor
  • Brian Davis, Honors Advisor
  • James Alan Miles, Faculty Reader
  • market efficiency
  • behavioral finance
  • finance
  • economics
  • rational inattention
  • status quo bias
The efficient market hypothesis is a financial theory that investors should not be able to outperform markets consistently because all information about a security is already reflected in its price. In examining literature regarding market efficiency, I stumbled across a quote from Warren Buffet’s will. As one of the most successful investors of all time, I was curious to discover what investment plans he made. In his will he requested that the trustee “put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund… I believe the … results from this policy will be superior to those attained by most investors.” There can be many reasons for doing this considering his tremendous net worth and current level of risk aversion. However, I decided to investigate this concept further to see if the returns produced by managed funds were changing. Using the returns produced by Berkshire Hathaway, I designed a proxy consisting of the CAGR differential between the fund and the S&P as a function of time. The first data point was the CAGR differential from the S&P starting at the fund’s inception in 1965 to present. (Appendix A) The following point is the same calculation from 1966 to present, and so on. According to this method, the fund seemed to be outperforming the S&P by less and less each year. The questions of this thesis are to determine whether or not this is a trend across managed funds, if it is continuing, and why. Though the results of this research are not definitive, there is strong support for evolving market efficiency from an analysis of behavioral finance and mutual fund returns.