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Running header: INVESTMENT IN AN IMPERFECT MARKET
Investment in an Imperfect Market
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INVESTMENT IN AN IMPERFECT MARKET
2
Steps of Investing in an Imperfect Market
Most decisions on investment made in the imperfect type of market need to be based not
on the opportunity cost, but on risk during the allocation of assets that are undervalued or
overvalued. When we consider the risk factor, most investors will be more exposed to changes
and will therefore be riskier. In an imperfect market setup, the market is said to be semi strong.
Hence, investing in such a market will need a combination of both active and passive strategies.
Since some sectors and securities end up being mispriced, the investors will fail to take
advantage of investing in stocks that are undervalued. In this case, the investors will choose to
stay passive since it is cheap and more efficient. Other investors will choose to go the active
investment way.in the case of active investment, some of the investors will attempt to study the
available information relating to the prices. Next, the investor will undertake active investment
with features of an imperfect market.
The approach of active investment tries to identify any aspects of mispricing that are
related to the timing of market performance. This will allow an investor identify the type of stock
that can outperform others in the market. One of the features of an imperfect market is that
information is not readily available. This means that the anticipated price of stock will not
always reflect the actual value of returns expected in the future. Hence, the imperfect market
setting will expose the different investors to various types of risks that are associated with stock,
in either undervaluation or overvaluation. Since the investors will be expecting the stock prices
to be reflected in the information in an imperfect market, this kind of condition will create
different kinds of results for the different investment portfolio.
Investors shall be required to choose portfolio among different industries so as to reduce
the exposure to risk. Investors are therefore encouraged to diversify the portfolio to a level of
minimum or no risk. Portfolio will however have some risk associated with it. According to
theory, the risky assets will generally have higher returns when invested in the long-term
investments compared to assets that are of low risk. This will therefore guarantee higher return in
the long-term investments and not in the short-term investments. Those investments that have
higher returns emanate from short term investments of high volatility. In order t maximize
returns, the investor will be required to allocate the different risks and r...