The following table lists Shleifer's 3 lines of defense for the efficient market hypothesis in the first column and empirical violations of these defenses in the second column. Which empirical violation supports the Shleifer's second line of defense, that even if quasi-rational traders are present, so long as their errors are uncorrelated they will cancel out and market prices still will reflect accurately underlying fundamental values? Lines of defense1. If all traders are rational, market priceswill accurately reflect underlyingEmpirical violationsa. The disposition effect; and stock marketoverreaction and subsequent meanreversion (as measured by De Bondt andThaler, among others).b. Excess stock price volatility and excesstrading volume; and high premiums forbearing risk (the equity premiumpuzzle).fundamental values.2. Even if quasi-rational traders are present,so long as their errors are uncorrelatedthey will cancel out and market pricesstill will reflect accurately underlyingfundamental values.c. Prices of twin shares that fail toconverge; and prices after equity carve-outs that fail to converge.3. Even when the errors of quasi-rationaltraders are systematic (i. e., they arecorrelated), any resulting mispricing willbe viewed as an opportunity for risk-freeprofits by the rational traders and undoneby arbitrage. Therefore, market pricesstill will reflect accurately underlyingfundamental values.

Introduction Fundamental value analyzes relevant economic and financial elements to determine a…

Answered: The following table lists Shleifer's 3…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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The following table lists Shleifer's 3 lines of defense for the efficient market hypothesis in the first column and empirical violations of these defenses in the second column. Which empirical violation supports the Shleifer's second line of defense, that even if quasi-rational traders are present, so long as their errors are uncorrelated they will cancel out and market prices still will reflect accurately underlying fundamental values?

Lines of defense
1. If all traders are rational, market prices
will accurately reflect underlying
Empirical violations
a. The disposition effect; and stock market
overreaction and subsequent mean
reversion (as measured by De Bondt and
Thaler, among others).
b. Excess stock price volatility and excess
trading volume; and high premiums for
bearing risk (the equity premium
puzzle).
fundamental values.
2. Even if quasi-rational traders are present,
so long as their errors are uncorrelated
they will cancel out and market prices
still will reflect accurately underlying
fundamental values.
c. Prices of twin shares that fail to
converge; and prices after equity carve-
outs that fail to converge.
3. Even when the errors of quasi-rational
traders are systematic (i. e., they are
correlated), any resulting mispricing will
be viewed as an opportunity for risk-free
profits by the rational traders and undone
by arbitrage. Therefore, market prices
still will reflect accurately underlying
fundamental values.

Definition Definition Degree to which financial markets incorporate all available information into the prices of assets. In a more efficient market, the prices reflect the available information more than that in a weak efficient market. It is difficult for investors to outperform the market in a strong efficient market. This is because all the available information is already discounted in the asset's price. However, in a weak-form efficiency, the market does not reflect all information in the asset's price. As a result, it becomes easier to generate better returns in a weak form or an inefficient market.

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