If investors can freely trade assets in financial markets, then the impact of trading activity on expected returns insures that ________________________.

Question

Quizplus · Accepted Answer

In efficient financial markets where investors can freely trade assets, the impact of trading activity on expected returns ensures that assets will have the same reward to risk ratio. This is because in such markets, assets are priced in a way that adjusts for their level of risk, aligning the reward to risk ratios across different assets. This principle is a cornerstone of modern portfolio theory, which posits that in an efficient market, the expected return on an asset, relative to its risk (as measured by beta in the Capital Asset Pricing Model, for example), should be consistent across all assets.

If Investors Can Freely Trade Assets in Financial Markets, Then