CFA Practice Question

CFA Practice Question

If it is found that security returns are correlated over time, this could be due to which of the following reasons?

I. The data could be faulty or may have come from different markets.
II. The model of security returns used could be incorrect.
III. The market could be weak form inefficient.
A. I and III
B. II and III
C. I and II
Explanation: Note that II is not relevant here because the correlation is calculated from observed data without assuming any particular model.

User Contributed Comments 10

User Comment
alexix what is weak form inefficient?
shasha ah, no model applied. thought we always got fantasy models for analysts.
jayjunk Weak form inefficient means that even the weak form efficiency of the market is not true. Weak form efficiency says that prices should not be predictable from publicly available information. But when you have correlation, you can (at an average) predict future price changes.
vadklim To jayjunk
I beleive that weak EMH says the prices should not be predictable from market information (historical prices and volumes) as that information actually incorporated in the prices, not from all public information (which includes also financials of companies and so on)
cfahitman vadkllm is correct

weak form EMH: not predictable from historical and market information (eg. technical analysis)
semi-strong EMH: not predictable from public available and historical information.
strong EMH: not predictable from both public and private information, and also from historical information.
cfahitman although we know ll is wrong and can guess that A is correct ans.
but it doesn't explain why l is relevant.

"may have come from different market".... how does this make the returns correlated over time? we don't expect returns from the Japanese market correlated to the U.S. market right?
staudinger Yes they would be correlated as they are part of the global economy.
alallstar how does correlation violate weak form efficiency? The returns of many stocks in related industries are correlated. This doesn't mean using historical/public data can help you predict future returns.
MaresaJaden I am having a hard time seeing how the market being weak form efficient explains the correlation of security prices over time?
chesschh This is what traders analyze
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