Efficient Markets

Question 1

“An efficient market is one where no one ever profits from having better information than the rest”. Is this statement true, false or uncertain? (2 marks) Explain your answer. (3 marks)

Answer 1

markets setting asset prices at a distance from fundamental values will lead to a misallocation of resources and potentially systemic problems - 3 forms of efficiency: operational (execute at min cost); informational efficiency (info avail is reflected in price and allocative efficiency (returns cannot be improved without increasing risk) - 3 forms under EMH: weak (past history incorporated); semi strong (publicly avail incorporated); strong (all info, whether public or inside info)

Question 2

Former US Federal Reserve Chairman Alan Greenspan once said, “There may be more forecasting of exchange rates, with less success, than almost any other economic variable.” The implication of Mr Greenspan’s comment is that relying on exchange rate forecasts cannot be rational. Is this statement true, false or uncertain? Explain. (5 marks)

Answer 2

true to uncertain depending on time frame. official cash rates are not adjusted in the near term unless there is a shock to growth / inflation - other rates/market prices are affected by news & developments

Question 3

Behavioral models can help explain why markets often move away from their fundamental/“fair” values. List five behavioral factors that explain why people might overpay for an asset.

Answer 3

Anchoring
Mental accounting 
Confirmation Bias
Overconfidence
Loss Aversion
Sunk cost fallacy
Framing Effect
Herding

Question 4

What is financial market/system failure? (2 marks) List three potential sources/drivers/causes of
failure in the financial market/system. (3 marks)

Answer 4

Where markets don´t achieve efficient allocation of resources.

1. imperfect information
2. asymmetric information
3. lack of competition

others:, public goods, externalities

Question 5

“An efficient market is one where no one ever profits from having better information than the rest”. Is this statement true, false or uncertain? (2 marks) Explain your answer. (3 marks)

Answer 5

Uncertain as there is more to an efficient market then information

Operational efficiency
Allocational efficiency
Informational efficiency