ording to the efficient markets hpothesis, even if many traders are irrational,
ID: 2786489 • Letter: O
Question
ording to the efficient markets hpothesis, even if many traders are irrational, trading by arbitrageurs, such as professional traders and hedge-fund managers, will quickly corret mispricing that arises from irrational trading. Arbitrageurs would sell overpriced securities short (thus driving their prices back down to fair valuation) and buy underpriced assets (thus driving their prices back up to fair valuation). Behavioraljsts, on the other hand, argue that important limits to arbitrage exist that prevent out-of-whack prices from being corrected. Which of the following are some of these limits? More than one answer may be correct. To earn full credit, you must select all of the correct answers and none of the incorrect answers O Arbitrage that involves selling short an overpriced stock and buying a fairly-priced or underpriced stock in the same industry is risky. Unforeseen good news about the overpriced stock could drive it higher, while unexpected bad news about the fairly-priced or underpriced stock could drive its price lower. Arbitrage positions may be hard to establish if a close substitute for the overpriced security is hard to find. O There are times when short selling is not possible or is severely constrained o Irrational pricing might continue longer than the arbitrageur can remain solvent. Solvency is an issue, because short-sellers need to meet margin calls (calls for additional collateral) as prices rise.Explanation / Answer
option 1 , 3 and 4 are correct,
sometimes short selling may not be possible ,also new information about the stock can cause underpricing or overprcing to actually become the fair value.
presence of alternate substitute has no affect on arbitrage
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