Does the Market Anticipate? Can it? Should it?

TL;DR

This paper examines how optimized trading strategies can suppress market anticipation of risk outcomes, revealing a bias that challenges traditional views on arbitrage and information efficiency.

Contribution

It introduces a novel continuous-time model allowing pre-horizon risk resolution and risk-neutral pricing, highlighting the tension between arbitrage, efficiency, and risk anticipation.

Findings

Optimized trading can create an apparent Status Quo Bias.

The model demonstrates suppression of risk anticipation in certain market conditions.

Results connect 'weak viability' and 'side information' to market efficiency.

Abstract

We explore a nuance to 'no arbitrage' in relation to 'information efficiency': acting immediately on an arbitrage is sometimes suboptimal; in such cases optimised trading can suppress the anticipation of predictable risk-outcomes, thereby creating an apparent Status Quo Bias, with Momentum and Low-Risk effects. This is shown in continuous time under model- or event-risk, where, unlike existing approaches, we allow pre-horizon risk-resolution and Risk-Neutral Equivalent pricing, with the technical challenges overcome through results from the 'weak viability' and 'side/inside information' literature. Thus the tension between 'no arbitrage', 'information efficiency' and 'risk-anticipation' is exposed and treated in a practically relevant setting.