CFA Level I · CFA Level I Exam · The Behavioral Biases of Individuals
Which view of market prices is most consistent with the behavioral finance perspective on markets?
The behavioral view is that prices can stray from fundamental value for long periods because investor biases create mispricing and arbitrage is limited. Traditional finance instead holds that prices fully reflect information and mispricing cannot persist.
- APrices may deviate from fundamental value for extended periods because of investor biases and limits to arbitrageCorrect
- BPrices always reflect all available information, so no mispricing can persist
- CPrices are determined solely by the risk-free rate and market beta
Explanation
Behavioral finance allows that biased investors can push prices away from fundamentals and that arbitrage may be limited, so mispricing can persist. Always-efficient prices are the traditional view, and a price set only by the risk-free rate and beta is a narrow CAPM statement.
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