CHAPTER 6 Foundations of Financial Economics
Financial economics serves as a vital foundation to asset pricing and the understanding of alternative investments. This chapter discusses informational market efficiency, asset pricing, forward contracts, and options.
6.1 Informational Market Efficiency
The concept of informational market efficiency is especially important in the management of alternative investments. Informational market efficiency refers to the extent to which asset prices reflect available information. An informationally efficient market is a market in which assets are traded at prices that equal their values based on all available information. The concept of informational market efficiency is sometimes referred to as efficient market theory or the efficient market hypothesis.
In practice, all financial markets display at least some informational market efficiency, but no financial market is perfectly efficient. For example, many trades of large equities on the U.S. stock exchanges occur at one-cent intervals, implicitly indicating at least some degree of mispricing. It is more useful to describe markets as displaying varying degrees of informational market efficiency rather than attempting to divide markets into those that are and those that are not informationally efficient.
6.1.1 Further Definitions of Informational Market Efficiency
Definitions of informational market efficiency often extend beyond the terse definition that “prices reflect available information.” ...
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