It is November 2026, and you are having dinner with an old friend from your days in college at NEU. Her name is Michelle, and she finished her undergraduate studies in Computer Science. She landed a job at a hedge fund where she is now a quantitative analyst, in charge of developing data-driven models that are used for stock trading. She tells you about a new stock trading idea that her team is currently working on, and wants to know your opinion about it. The conversation between you goes as follows:

Michelle: One of the courses that I took during my undergrad studies at NEU was on textual analysis using various artificial intelligence algorithms. I learned how to develop computer programs that can automatically download massive amounts of texts from the internet, clean them, analyze them, and make recommendations based on them. I am now applying these techniques on this new trading strategy where we download and analyze data from a text storage website named Pastebin.

You: Wait, isnt that the website where anonymous hackers upload breached passwords and stolen credit card information?

Michelle: Exactly! Most of this information is stolen from company databases that include their customer information. Our algorithm constantly browses the website to identify which firms are potentially attacked by hackers and have their databases breached. For a firm, it is a nightmare to have its customers information - including their names, credit card information, and sometimes even their social security numbers - leaked online. Such incidents are usually followed by class action lawsuits against these firms. Do you know how costly that could be for the firm?

You: Millions of dollars?

Michelle: Yes, and mostly in billions of dollars. Usually, when a firm announces that they have been subject to a data breach, its stock price drops like a rock! Using this algorithm, we get to find out which firms are hacked before any public announcement is made about it. We just short sell the stock right away, well before the breach is formally announced by the firm and everyone knows about it.

You: Wellregardless of the legality of what you are doing, is it even profitable?

Michelle: Well, Pastebin has been around for only 20 years now, and thats how many years of data we have for testing our strategy. But our results show that this strategy generates, on average, 12% return per year (compared to 8% for the S&P500 index)."

You: Wow thats impressive!

Michelle: Yeah! Looks like the market isnt efficient after all!

You: Not so fast my friend!! It doesn't necessarily suggest that!

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Please respond to the following questions:

Part 1:

Why does Michelle believe that this observation is evidence against market efficiency? In your answer, please specify which form of market efficiency you think that she believes has been violated, and provide your reasons for why you think it is not the other two forms of market efficiency that have been violated.

Part 2:

Provide counter-arguments for Michelles reasons based on your conversation. In other words, explain why you said Not so fast my friend!! It doesn't necessarily suggest that!

Please keep your discussion to 400 words or fewer, and feel free to divide it between the two parts as you wish. Note that this is an upper limit; if you can cover your points in fewer words, this is fine.