It is a characteristic of human nature that they take rational decisions generally.

For instance, if a
person is given two options to choose from, he opts for the one that has more utility attached to
it. Standard expected utility theory advocates that a person should pick those items from a lot
that have maximum expected benefits. The theory deals with optimizing decisions where risk is
involved (Lewandowski, 2017). However, there are some circumstances when decisions taken
are based on rationale that are inconsistent with this theory (Kahneman & Tversky, 2013). The
behavior changes when one is expected to but lottery ticket. They give more weight to those
outcomes which have high uncertainty and amount. If the options are evaluated on the basis of
expected utility theory, one shall never purchase a lottery as the outcome multiplied by its
probability would come to lower than the cost of the ticket but people’s perception tend to differ
here. They expect probability to favor them. One of the report of Business Insider (2016) claims
that the brain of people has not evolved to understand the probabilities of lottery. The world’s
largest lottery firm El-Gordo distributed a sum of €2.5B in 2012 (BBC, 2012).

A series of surveys conducted in past to observe decision making for buying lottery tickets
showed that people are risk averse for wining situations and risk seeker for possible losses. Most
people choose to pay $6 to buy a lottery ticket with bumper prize of $5,000 but with a low
probability of 0.001. They put more weight to the uncertainty factor and hope to win. The
situation brings prospective theory into picture, where people don’t act as per what they should
be doing (i.e. EU theory) but what
they feel right at that moment. It’s not
heuristic but systematic. Their logical
Metrix system guides them in making
such decisions that look irrational on
the scale of EU theory but actually are
very impressive tool when it comes to
hedging. Prospect theory argues that
people don’t take utility decision in
isolation, they take it with reference to
some point – say x and they overweigh Figure 1: Graph showing Prospect theory value function
extreme outcomes. For example: If a
person is asked to put money in a lottery, he will buy a ticket for a few pounds for a very high
limit as he is a risk averse for gains but the same person will buy insurance cover of much
amount than the lottery limit and will also pay more amount in premium. This signifies the
human psychology. The prospective function can be understood from the figure 1 which shows
that the psychological values changes faster in case of loses than gains.

The psychological desire to buy lottery tickets is derived from many factors, one of the important
is that they want financial freedom. People want to buy things they don’t deserve (Goodwin &
Barbara, 2013), they want vacations, advanced gadgets, better lifestyle but the life does not give
equal opportunities to all or it can be said that the opportunities are not effectively utilized by all.
Chicago Tribune (2018) in an article reported that people tend to enjoy the fantasy related to the
purchases they want to made with the lottery money. They win or loose doesn’t affets the
psyclological pleasure they obtain from fantacised purchases. Another important reason is
Gambler’s fallacy, the belief is that some events if occurred frequently over a period will not
occur in the sunsequent period (Chen, et al., 2016). Ofcourse the belief is baseless but appealing.
However, the philosophy that stocks perform well over a longer period of 10 – 30 years hold true
in case of financial management but this can not be taken as decisive example to hold the
gambler’s fallacy true. But people behave with this psychology. When they start to loose, they
feel the series will wnd soon and they will start winning. To recover the losses they made, they
put more and more money. Sometimes they win and evry time the lottery company. The same
article in Chicago Tribune (2018) quotes that “people are crazy”.
Efficient market hypothesis states that markets are efficient (Sewell, 2011). The hypothesis
claims that under efficient market no arbitrage opportunity exists. Stock are neither overvalued
nor undervalued. No expert can take advantage through his expert knowledge. Information is
freely accessible to all participants – both public and private.

a) The investment in equity shares generally gives more return as at lower level numerous
opportunities exists that require low investments comparatively. These small but
potentially rich opportunities need special management focus. Yang, Zheng and Zhao
(2014) argue that alliance of small company with big corporations enable them to
increase their firms value fast. The return is high but concluding that it is due to efficient
market is not true. Efficient market talks about the charecteristics of market. Small firms
are risky but they have the potential to grow and irrespective of EM the better ones will
be performing well in any case.
b) UK financial year begins from 1st January and closes on 31st December. The results are
published after that. The impact of publication of results is always there be it a big
company or a small company. The share prices are affected for both but before that there
is a little show in the last week of December and first week of January when the stocks of
small companies generally perform well (Patel, 2016). Main reasons for the phenomena
include hard work of employees to complete the targets which eventually boost the
business and ultimately increases the overall value. Other reason is window dressing
done by these companies, these are small and it’s easier to window dress them as
compared to large corporations which are highly regulated and monitored. However, it’s
not the characteristic of efficient market hypothesis as under EM there is no such scope
of window dress of last moment adjustments.
c) Index funds are mutual funds with exact same proportion of investments that the index
represents. Investing in these funds means investing in the index companies in the same
proportion. The benefit is that these are easy to monitor and are the best stocks in the
market up to a certain level of satisfaction. The EM hypothesis argues that the index
performs the best over a long period of time than any other portfolio of investments. No
matter how good a professional manager would be managing his funds it is believed that
in very long run under EM the index will outperform everyone.
d) Individual traders are comparatively less skilled and informed than professional
managers. They take decisions fast with less information. Any chances where they face
that their investments are on the edge of extreme loss they don’t hesitate to sell it and for
extreme gain cases it’s very difficult to resist. Under efficient market, the extreme gains
and losses are very rare and it make no difference to individual traders, professionals or
financial institutions. They all receive the information and take decisions accordingly.
e) The current era is Technology’s era. We have witnessed that top 5 companies in terms of
net worth are Apple, Amazon, Alphabet, Microsoft and Facebook (Statista, 2018).
Technology is their core competency, it is pervasive in both professional and personal
life. High-Tech stocks have performed very well in the past, all of these organizations
were not existing 40 years ago. However, we have witnessed the dot com bubble crash in
which many startups settle down with their first sunset (Business Insider, 2010). It is true
that tech sector is growing at much faster rate, they make 26% of S&P 500 in the year
2018 in US (CNBC, 2018), which is second highest after the year 2000 (see graph
below). However, this cannot be solely attributable to efficient market as the hypothesis
is unbiased to a particular industry. Every industry will grow at normal rate, it’s the
demand for technology and tech firms are meeting the expectations by delivering
impressive products and getting rewarded by high market valuations.

f) Gordon has argued that dividend is the most important factor in determining the share
price of a company (Yahoo Finace, 2017). Majority of investors always prefers stock
with greater dividends. Investors are risk averse, they prefer released dividends over
capital gains. Gordon’s dividend discount model values the share as capitalized value to
expected dividends where the rate if cost of equity less growth. However, this is not a
distinct case with Efficient market hypothesis. A risk averse investor will always demand
dividend be it EM or not.
References
BBC, 2012. Luck of the draw: Comparing lotteries. [Online]
Available at: https://www.bbc.com/news/world-17564285
[Accessed 25 March 2019].

Business Insider, 2010. Here's Why The Dot Com Bubble Began And Why It Popped. [Online]
Available at: https://www.businessinsider.com/heres-why-the-dot-com-bubble-began-and-why-
it-popped-2010-12?IR=T
[Accessed 25 March 2019].

Business Insider, 2016. 3 psychological reasons why we buy lottery tickets when there's virtually
no chance of winning. [Online]
Available at: https://www.businessinsider.in/3-psychological-reasons-why-we-buy-lottery-
tickets-when-theres-virtually-no-chance-of-winning/articleshow/50568262.cms
[Accessed 25 March 2019].

Chen, D., Moskowitz, T. & Shue, K., 2016. Decision making under the gambler’s fallacy:
Evidence from asylum judges, loan officers, and baseball umpires. The Quarterly Journal of
Economics, 131(3), pp. 1181-1242.

Chicago Tribune, 2018. Buying lottery tickets? Experts say you 'might as well burn the money' —
but dreamers play on. [Online]
Available at: https://www.chicagotribune.com/news/ct-met-lottery-math-mega-millions-jackpot-
20181022-story.html
[Accessed 25 March 2019].

CNBC, 2018. Booming technology stocks are testing the limits of investors' appetite for one
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Available at: https://www.cnbc.com/2018/09/05/booming-technology-stocks-are-testing-the-
limits-of-investors-appetite.html
[Accessed 25 March 2019].
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Kahneman, D. & Tversky, A., 2013. World Scientific. [Online]
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Lewandowski, M., 2017. Prospect Theory Versus Expected Utility Theory: Assumptions,
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Modelling and Econometrics, pp. 275-321.

Patel, J., 2016. The January effect anomaly reexamined in stock returns. Journal of Applied
Business Research, 32(1), p. 317.

Sewell, M., 2011. History of the efficient market hypothesis. Rn, 11(04), p. 04.

Statista, 2018. The 100 largest companies in the world by market value in 2018 (in billion U.S.
dollars). [Online]
Available at: https://www.statista.com/statistics/263264/top-companies-in-the-world-by-market-
value/
[Accessed 22 February 2019].

Yahoo Finace, 2017. Yahoo Finance. [Online]

Available at: https://finance.yahoo.com/news/fedexs-dividend-hike-worth-recent-
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[Accessed 25 March 2019].

Yang, H., Zheng, Y. & Zhao, X., 2014. Exploration or exploitation? Small firms' alliance
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