Practice Question
For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels:
A) The expected rate of return must be equal to the required rate of return.
B) Ex-ante return must equal ex-post return.
C) The past realised return must equal the expected rate of return.
D) All three A, B, C must hold.
E) None of the above statements are correct.
Market equilibrium means there's no excess buying or selling pressure to push the asset price up or down. In this context:
This is the necessary condition for equilibrium. If expected returns exceed required returns, investors will rush to buy, pushing the price up until the two rates equalize. The reverse happens if expected returns fall short.
This is not necessary for equilibrium. It implies perfect foresight, which is unrealistic in financial markets.
Past realized returns don’t have to equal expected returns. Past performance doesn’t guarantee future returns.
Only statement A is required for markets to be in equilibrium.
Final Answer: A)