Question

1)Why Arbitrage Opportunities imply that the Efficient Market Hypothesis hold ? Explain...

Answer 1

As per Efficient Market Hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices.

Arbitrage Opportunities imply that the Efficient Market Hypothesis hold due to the following reasons:

1. Talented traders at hedge funds who will take prices that are out of line and bring them back into line, making a good fee and making prices reflect all available information thus the very building block necessary for EMH to work, can’t do their job if they are time or credit constrained.
2. If market adjust quickly to arbitrage opportunities to return back to normal without cost of any other investor and through market mechanism then market can be said efficient.
3. Arbitrage is possible in an efficient market by offsetting the same contract on two exchanges, futures and options as an example.
4. Arbitrage only takes care of cases where two assets are substantially equivalent. That's only a small fraction of the mis-pricing that could occur.

So both arbitrage opportunities and market efficiency can exist together.