Apparent Inefficiency in the Market

B

The correct answer is B. This apparent inefficiency in the market may persist and even grow larger before any correction occurs.

Explanation: In an efficient market, where prices fully reflect all available information, securities with similar risk characteristics should offer similar expected returns. However, in this scenario, two stocks have identical risk but different expected returns. This suggests an apparent inefficiency in the market.

Option A states that the inefficiency indicates that arbitrageurs must be unaware of the mispricing. However, in an efficient market, arbitrageurs are typically quick to identify and exploit mispriced securities, thereby driving prices back to their fair values. The fact that the mispricing persists suggests that arbitrageurs might not be unaware of it.

Option C suggests that the inefficiency can only arise when arbitrageurs lack the capital to exploit the situation. However, the presence or absence of capital does not determine the persistence of a mispricing. If the mispricing were evident and exploitable, arbitrageurs could typically seek funding or collaborate with other investors to take advantage of the opportunity.

Option B correctly states that the apparent inefficiency may persist and even grow larger before any correction occurs. This is known as a market anomaly or pricing anomaly. It suggests that there might be factors or information that market participants have not fully considered or incorporated into their pricing decisions. As a result, the mispricing can persist until new information becomes available or market participants reassess their valuation models.

In summary, the correct answer is B because the persistence and potential growth of the apparent inefficiency before any correction occurs are consistent with market anomalies observed in real-world situations.