{"id":1854,"date":"2019-06-15T17:35:00","date_gmt":"2019-06-15T17:35:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=1854"},"modified":"2025-12-29T23:01:41","modified_gmt":"2025-12-29T23:01:41","slug":"factors-affect-markets-efficiency","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/equity\/factors-affect-markets-efficiency\/","title":{"rendered":"Factors that Affect a Market\u2019s Efficiency"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"As more market participants opt for passive management over active management, market efficiency is likely to:\",\n    \"text\": \"As more market participants opt for passive management over active management, market efficiency is likely to:\\n\\n1. Increase.\\n2. Decrease.\\n3. Remain unchanged.\",\n    \"answerCount\": 3,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is B: market efficiency is likely to decrease. Passive management reduces the number of active participants exploiting inefficiencies, so fewer participants are working to correct mis\u2011pricings.\"\n    },\n    \"suggestedAnswer\": [\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"A: Increase \u2014 incorrect. Passive management does not actively exploit inefficiencies.\"\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"C: Remain unchanged \u2014 incorrect, because reducing active participation tends to reduce the pressure to correct mis\u2011pricings.\"\n      }\n    ]\n  }\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Market Efficiency (2025 Level I CFA\u00ae Exam \u2013 Equity \u2013 Module 3)\",\n  \"description\": \"This video lesson covers market efficiency and its relevance for investment practitioners. It explores key concepts such as intrinsic vs. market value, forms of market efficiency, and their impact on analysis strategies. The lesson also examines market anomalies and introduces behavioral finance to explain deviations from efficient market theory.\",\n  \"uploadDate\": \"2022-05-10T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/7Ub4Gt-0nMs\/maxresdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=7Ub4Gt-0nMs\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/7Ub4Gt-0nMs\",\n  \"duration\": \"PT1H05M44S\"\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/7Ub4Gt-0nMs?si=8NVm0NSZMAtvUaWz\" title=\"YouTube video player\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe>\n\n\n<p>Most, if not all, markets can be thought of as existing on a spectrum between perfect efficiency and complete inefficiency. This is because several factors contribute to or impede the efficiency of a market, including market participants, information availability and financial disclosure, and limits to trading.<\/p>\n<h2><strong>Market Participants<\/strong><\/h2>\n<p>In general, as the number and sophistication of participants within a market increase, the market becomes more efficient.<\/p>\n<h2><strong>Information Availability and Financial Disclosure<\/strong><\/h2>\n<p>The more information market participants have, the more accurate the market\u2019s estimates of intrinsic value, thus creating greater market efficiency. In highly efficient markets, information is provided to all market participants simultaneously, and the advantage of insiders is limited.<\/p>\n<h2><strong>Limits to Trading<\/strong><\/h2>\n<p>The act of arbitrage is believed to increase market efficiency. Pure arbitrage typically involves buying an asset in one market and selling the same asset in a different market at a higher price. For example, when market participants believe a security is overvalued, they can perform a short sale \u2013 or the sale of a borrowed security. Some regulators argue that short selling puts inefficient downward pressure on securities leading to market crashes, but research generally shows that short selling helps supply and demand effectively determine market prices.<\/p>\n<h2><strong>Transaction Costs and Information Acquisition Costs<\/strong><\/h2>\n<p>Traders incur these expenses in order to locate and take advantage of potential market inefficiencies.<\/p>\n<p><b>Transaction costs<\/b> are the charges and fees incurred when purchasing or disposing of a security. Brokerage commissions, bid-ask spreads, taxes, and any other expenses incurred during trade execution are examples of these costs.<\/p>\n<p><b>Information-acquisition costs<\/b> are the charges incurred in order to gather pertinent data regarding a security or investment. Research charges, data subscription fees, financial analysis tools, and other resources used to collect and process data can all be included in these costs.<\/p>\n<blockquote>\n<h3><strong>Question<\/strong><\/h3>\n<p>As more market participants opt for passive management over active management, market efficiency is likely to:<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Increase.<\/li>\n<li data-tadv-p=\"keep\">Decrease.<\/li>\n<li data-tadv-p=\"keep\">Remain unchanged.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>Passive management does not generally try to exploit market inefficiency but instead assumes that the market is highly efficient and passive investors will ultimately earn higher returns by reducing management fees as much as possible. At least, in theory, the popularity of active over passive management has an inverse relationship to its effectiveness. Therefore, as passive management becomes more common, there are fewer active market participants to find and profit from price inefficiencies, and market efficiency is likely to decrease.<\/p>\n<\/blockquote>","protected":false},"excerpt":{"rendered":"<p>Most, if not all, markets can be thought of as existing on a spectrum between perfect efficiency and complete inefficiency. This is because several factors contribute to or impede the efficiency of a market, including market participants, information availability and&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[8],"tags":[],"class_list":["post-1854","post","type-post","status-publish","format-standard","hentry","category-equity","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Factors Affecting Market Efficiency | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Explore key factors influencing market efficiency, from information availability to trading costs and investor behavior.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, 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