Question: Suppose two identical properties are traded in two different asset markets: property A in a relatively inefficient or sluggish market and property B in a more efficient market. When news arrives relevant to asset value, property A's market value will move only halfway to the new value in the first period, and the rest of the way in the next period. Property B's value will move all the way to the new value in the first period. At the beginning of period 0, both properties are worth $1,000. Then news arrives that implies they should be worth 10% more.
a. In the absence of any further news, how much will property A and property B be worth at the end of period 1 and period 2?
b. In the absence of transaction costs, and assuming you can borrow $1,000 for two periods at $50 interest, how much money could you make (and how could you make it) by trading between the two properties across the two markets? (Assume that at the beginning of the dealing you do not own either property, and at the end you cash out completely, paying back any loaned money.)
c. Suppose the transaction costs are 3% of property value each time you either buy or sell a property (but loan transactions are free). Now what is your profit or loss from the same transactions as in (b)?