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

Under the strong form of the efficient markets hypothesis, which statement about insider dealing in an Indian listed company is correct?

Under strong form efficiency, prices reflect all information including private information, so insiders cannot earn abnormal returns from it. Empirical evidence generally rejects this form, which is one reason insider dealing is regulated and prohibited.

  1. AInsiders cannot earn abnormal returns because prices already reflect even private informationCorrect
  2. BInsiders can earn abnormal returns because private information is not yet in prices
  3. CInsider dealing is only profitable if past prices are analysed
  4. DInsiders earn abnormal returns only when markets are weak form inefficient
  5. Strong form efficiency applies only to public announcements

Explanation

Strong form efficiency says prices reflect all information, public and private. Hence even insiders with private information cannot earn abnormal returns. In practice evidence rejects strong form, which is why insider dealing is prohibited and policed.

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