Chapter 4: Discussion Questions and Problems
1. Differentiate the following terms/concepts:
a. Momentum and reversal
With momentum we observe positive correlation in returns, whereas with reversal we
observe negative correlation in returns.
b. Value and growth stocks
c. Fundamental risk and noise-trader risk
d. Carve-out and stub value
2. Refer back to the set of exchange rates in the “Support 3: There are no limits to
arbitrage” section earlier in the chapter. Describe a profitable arbitrage strategy
if x = 105.
3. Arbitrage is limited because the wealth of arbitrageurs is limited. Discuss this
statement in the context of those who are managing their own money and those
who are managing other people’s money.
When you managing your own money, you are subject to fundamental risk and noise–
4. What is data snooping? What sort of empirical evidence is useful for obviating
this critique?
5. What are the three supports on which market efficiency rests? Why is it that
only one of them is required?
The three supports are investor rationality, uncorrelated errors and unlimited arbitrage.