Question

Which of the following observations would provide evidence against the strong form of efficient market theory?

I) Mutual fund managers do not on average make superior returns.
II) In any year approximately 50% of all pension funds outperform the market.
III) Managers who trade in their own firm's stocks make superior returns.

A. III only
B. I only
C. I and II only
D. II only

Answer 1

Evidence against the strong form of efficient market theory would be provided by managers who trade in their own firm's stocks and make superior returns, implying access to insider information not reflected in stock prices. The correct answer is A. III only, as this contradicts the strong form of market efficiency.

Step-by-step explanation:

The observation that would provide evidence against the strong form of efficient market theory is that managers who trade in their own firm's stocks make superior returns.

This would imply that some individuals have access to information that is not available to the public, which contradicts the strong form of market efficiency that asserts all information, public and private, is reflected in stock prices. Therefore, the answer is A. III only.

The strong form of the efficient market hypothesis (EMH) states that the market incorporates all information, both public and private, in the pricing of securities and that no trader can consistently achieve superior returns.

Observation I) Mutual fund managers do not on average make superior returns and II) In any year approximately 50% of all pension funds outperform the market are consistent with the efficient market hypothesis if taken in isolation.

Managers trading on their own firm's stocks and making superior returns would suggest they possess insider information, which the market has not yet priced in, threatening the validity of the strong form EMH.