Question

Which of the following is/are true? Explain your reasoning.

1. Search costs are higher to identify violations of weak-form efficiency than violations of semi-strong form efficiency.

2. In an efficient market, random selection is sufficient to manage portfolio risk.

3. Evidence that a portfolio manager outperformed the S&P 500 last year is

   inconsistent with the semi-strong form of the efficient market hypothesis.

4. A violation of strong-form efficiency implies a violation of semi-strong form

   efficiency.

Answer 1

1. The efficient market theory says that there is not arbitrage gain or loss in a perfectly efficient market, since all information freely flows and the share prices reflects the fair market value of the stock.

Of which there is the strong efficiency, weak efficiency and semi -strong

Weak form of efficiency means the stock prices reflect historical data alone.

Semi-strong suggests that public information affects the share price, and only non-public information can affect the share price.

Search costs, are hence higher for identifying Semi-strong form efficiency, since both public and historical information is considered.

FALSE

2. In an efficient market, random selection is sufficient to manage portfolio risk.

TRUE

Since stocks are never overvalued or undervalued, a random selection is sufficient to manage portfolio risk.

3. Evidence that a portfolio manager outperformed the S&P 500 last year is inconsistent with the semi-strong form of the efficient market hypothesis.

FALSE

Semi - strong suggests public information is not sufficient to beat the market. Hence if a portfolio manager beats the S&P then it suggests weak form of efficiency.

4. A violation of strong-form efficiency implies a violation of semi-strong form

A violation of strong-form of efficiency could imply the arbitrage could be from non-public information , or from public information. Hence it could be either weak / semi- strong.

Hence FALSE>