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IAI Actuarial Core Principles · Economic Modelling · Rational expectations theory and the efficient markets hypothesis

An actuary values a life insurer's equity portfolio on a market-consistent basis. Which assumption about market efficiency best supports using observed market prices as the asset values?

Market-consistent valuation is supported by the assumption that prices reflect available information, so observed market value is the best estimate of fair value. Assuming systematic overpricing, predictable trends or delayed adjustment would contradict market efficiency.

  1. APrices reflect available information, so market value is the best estimate of the fair value of the assetsCorrect
  2. BPrices always exceed intrinsic value, so a discount should be applied to market value
  3. CPrices follow a deterministic trend, so values can be projected exactly
  4. DOnly insiders know true values, so market price is unreliable for all investors
  5. Prices adjust only after a year, so a lagged price should be used

Explanation

If markets are reasonably efficient, price reflects available information and is an unbiased estimate of fair value, justifying market-consistent valuation. The other options assume systematic bias, predictability or delayed adjustment, which contradict efficiency.

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