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

An actuary values a with-profits fund's equity holdings using market prices, relying on the efficient markets hypothesis. Which consequence of semi-strong efficiency supports this valuation approach?

Market prices are unbiased reflections of fundamental value given public information, so they should show no systematic mispricing. This justifies using market values for assets in valuation. Efficiency does not imply deterministic prices, perfect correlation, or any link to the value of liabilities.

  1. AMarket prices are always equal to the discounted value of the fund's liabilities
  2. BMarket prices are unbiased estimates of fundamental value given public information, so no systematic over- or undervaluation should be expectedCorrect
  3. CMarket prices never change without new information about dividends
  4. DMarket prices follow a deterministic path that can be projected from past returns
  5. Market prices of different shares are perfectly correlated

Explanation

If the market is semi-strong efficient, prices reflect all public information, so they are unbiased estimates of fundamental value and market-consistent valuation is justified. Efficiency does not mean prices are constant, deterministic or tied to liabilities, and it does not imply perfect correlation.

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