Sara has $15,000 to invest for 1 year. She has narrowed her choice to one of two companies: 

a1: Invest $15,000 in shares of Tech Ltd. 

a2: Invest $15,000 in shares of Pharma Ltd. 

 

The payoff from these investments depends on the success of their new product launch. If the product is successful, Sara will earn a net return of $2,000 on Tech shares and $1,500 on Pharma shares. If the product is not successful, she will earn $500 on Tech shares and $1,000 on Pharma shares. 

 

Sara's prior probabilities on the success of the new product launch are P(S) = 0.55 and P(F) = 0.45. S means the product launch is successful, and F means it is unsuccessful. 

 

Sara is a rational, risk-averse decision-maker with utility equal to the square root of the net return on her investment. Before acting, Sara decides to obtain more information. She obtains the recent financial report of Tech and studies its research and development (R&D) disclosure. Sara knows that Tech company management has the best (inside) information on the success of their new product launch and that some of this information will be revealed in R&D disclosures such as development costs, patents applied for and granted, and scientific publications. Her examination reveals good news (GN), that is, management's R&D actions suggest it expects the product launch will be successful. Sara knows that if the new product launch is going to be successful, there is a 0.7 probability that R&D will show GN. However, if the new product launch is not going to be successful, there is a 0.4 probability that R&D will show GN.

The table below summarizes Sara's posterior probability about the success of the new product launch:

 

	Economic Outlook
Successful	0.7	0,3
Unsuccessful	0.4	0.6

Required :

a. Given the state was BN in R&D, which act should Sara take now? Use Bayes Theorem to support your answer.? (6 Points)

 b.  What is your personal opinion on the accuracy of the efficient market hypothesis in explaining the behavior of financial markets? Can you provide examples or evidence to support your views? Additionally, are there any limitations or criticisms of the efficient market hypothesis that you find convincing, and why do you think these critiques are significant?

Answer rating: 100% (QA)

a To determine which action Sara should take given the state of RD showing Good News GN we can use Bayes Theorem to calculate the posterior probabilities Lets define the events A1 Invest in Tech Ltd A... View the full answer