Operating inefficiencies reduce market efficiency
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Market efficiency can be understood by 2 explanations-:
Thus, in an efficient market, there would be no mispricing.
However, if there are operating inefficiencies such as transaction costs, taxes, restriction on short selling, etc, there might be mispricings in the market price which we cannot exploit and so markets would be inefficient.
Eg 1: Stock A is overvalued, the market price is 100 and the intrinsic value is 80. In an efficient market, participants (traders) would immediately short sell the stock until the market price falls to 80. However, if short selling is not allowed, this inefficiency in the price cannot be removed.
Eg 2: If a stock trades at 100 in one market and 105 in another, in an efficient market, arbitrageurs would buy the share in the first and sell in the second until the price in both the markets is equal. However, if there are transaction costs and taxes above 5, then the opportunity to arbitrage is not there, so there is bounded efficiency.
Hope this helps!