LOS c: Explain why an apparent anomoly may be justified and describe the common biases that distort testing for mispricings.

Q1. Which of the following statements concerning efficient markets and anomalies is the least likely to be correct?

A)   The arbitrage required to exploit an anomaly may not be riskless because there is no guarantee that the price will return to fair value.

B)   Strategy risk refers to the fact that the model used to adjust for risk may not be correctly specified.

C)   Processing information has a cost and takes time, so some market participants may be rewarded for performing fundamental analysis if they act quickly.

Q2. Which of the following is least likely a reason that investors should be skeptical of reported market anomalies?

A)   Data mining.

B)   Synchronous trading.

C)   Strategy risk.

LOS c: Explain why an apparent anomoly may be justified and describe the common biases that distort testing for mispricings.fficeffice" />

Q1. Which of the following statements concerning efficient markets and anomalies is the least likely to be correct?

A)   The arbitrage required to exploit an anomaly may not be riskless because there is no guarantee that the price will return to fair value.

B)   Strategy risk refers to the fact that the model used to adjust for risk may not be correctly specified.

C)   Processing information has a cost and takes time, so some market participants may be rewarded for performing fundamental analysis if they act quickly.

Correct answer is B)        

Strategy risk refers to the fact that anomalous behavior identified in historical data may not persist into the future, or, at least, during the timeframe within which the strategy is executed. Incorrectly specifying the risk-adjustment mechanism is a modeling issue.

Q2. Which of the following is least likely a reason that investors should be skeptical of reported market anomalies?

A)   Data mining.

B)   Synchronous trading.

C)   Strategy risk.

Correct answer is B)        

Nonsynchronous trading is a reason to be skeptical of market anomalies. For stocks that trade infrequently, closing prices may be prices from much earlier in the day. Using these “stale” prices can make strategies appear attractive that are not. Assuming that one could actually trade at closing prices at or near the close of the market may make a strategy look profitable when the strategy could not really be implemented.

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