15 – M4 L3b 15 IVol Arbitrage And Efficient Pricing Of Stocks V3

You may recall that overcharge is a process that seeks profits due to mis-pricing of assets. In other words, overcharge looks for inefficiencies in the market in order to profit from these inefficiencies. Moreover, the act of overcharge actually reduces the mis-pricing of assets, and the individual acts of overcharge by market participants as a whole add up to support a more efficient market. When we think of profit seeking activities in their role in maintaining efficient pricing in markets. It can also include buying stocks that are considered under-priced or shorting stocks that are considered over-priced. In other words, overcharge here is that the instantaneous buying and selling of perfect substitute assets. Here, we simply mean buying assets with an expected return greater than that warranted by the risk taken, and similarly shorting assets with an expected negative return that is less than that warranted by the risk taken. Even though only taking a long or only taking a short position is not technically overcharge, when market participants seek to profit from mis-priced assets, their actions help to reduce that mis-pricing and make markets more efficient.