Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which of the following are considered market anomalies by fund managers?

1. Legal insider trading, price momentum, short selling, accounting accruals.

2. Legal insider trading, price momentum, accounting accruals.

3. Price momentum, short selling, accounting accruals.

4. Legal insider trading, price momentum, short selling.

The correct answer is: Legal insider trading, price momentum, short selling, accounting accruals.

Market anomalies refer to patterns or trends in financial markets that contradict the efficient market hypothesis, which asserts that asset prices reflect all available information. The correct choice identifies legal insider trading, price momentum, short selling, and accounting accruals as phenomena that challenge traditional financial theories. Legal insider trading acts as an anomaly because it involves individuals with non-public information making trades, which can lead to disproportionate gains and influence stock prices in ways that market efficiency would not predict. The presence of insider information can skew the informational efficiency that investors rely on. Price momentum is recognized as an anomaly because it reflects the tendency for securities that have performed well in the past to continue to do so in the short term, contradicting the idea that prices always adjust to reflect true values quickly and accurately. Short selling is another anomaly as it counteracts the notion of buying and holding being the only viable long-term strategy. It allows fund managers to capitalize on overvalued assets, taking advantage of price declines, which doesn’t align with an efficient market where such strategies would be neutralized by equal trading opportunities. Accounting accruals are considered an anomaly as they involve differences between accounting earnings and actual cash flows. This discrepancy can mislead investors regarding the true economic performance of a company,