Question

Which of the following sources of market inefficiency would be most easily exploited?

a. A stock price drops suddenly due to a large block sale by an institution.

b. A stock is overpriced because traders are restricted from short sales.

c. Stocks are overvalued because investors are exuberant over increased productivity in the economy.

Short answer

The correct answer is ‘c’.

Step-by-step solution

Definition

Market inefficiency refers to a condition where an asset’s price is not truly reflected with all the available information.

Explanation

In a weakly inefficient market, it is unlikely that there would be exuberant investors over increased economic productivity. On the contrary, this is a predictable pattern on returns. In the above scenario, the overvalued stocks without any regulatory mechanisms would provide investors to manipulate price and earn huge profits.