WHY DO EXPLORATION and production companies make more acquisitions, buy back more stock, and invest more in growing and developing their reserves when the commodity price is high and these uses of capital are at their most expensive levels? Why do they lever up at the top of the cycle when there seems to be more downside than upside? These actions seem at odds with the rational concept of “buy low and sell high.” Can behavioral finance explain these seemingly irrational behaviors?For over half a century, business school students have been trained in the efficient market hypothesis which asserts that investors cannot “beat the market” because the stock market is so efficient that share prices reflect essentially all available information at all times. In their economics classes, these students have been taught how investors always make rational decisions that are in their best self-interest. Given the volatility in the oil and gas industry, many undoubtedly wonder how efficient the market is and how rational investors are. How do we explain the apparent market inefficiency and irrational behaviors?
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