The Tests for Market Efficiency

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Recommended: Characteristics of market efficiency

During the 20th century, academic financial economists extensively accepted the efficient market hypothesis. Almost everyone was alleged that stock markets and securities market are highly efficient in response to any new information in the market. It was argued that when information regarding factors influencing market arises, the information spread like wild fire in the market and the prices of stocks adjust accordingly without any delay. This means that neither the fundamental analysis related to analysis of financial information of the company such as earnings, capital stock etc nor the technical analysis related to the analysis of historical performance of the stocks of the company enables the investor either experienced or not to get return over and above the average return of the market by holding any portfolio of stocks with average market risk.

A random walk and efficient market hypothesis are associated because random walk is a term often used in the literature of finance which argues that the further price change in the stocks is independent of any pattern based on the historical trend of price change. The logic behind random walk idea is that the change in the price of stock in any trading session is based on the information available in the market and price change in the next trading session is independent of the change price change in the previous session due to the reason that the next day change in price reflects the impact of information available to them. It is also important to note in consideration to random walk idea is that the information is unpredictable so the change in the stock price is also unpredictable. This means that the change in price of stock during any trading session fully reflects the impact...

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...n Wall Street (New York: W. W. Norton & Co., 1973, 1st edition.)

––––––– “Returns from Investing in Equity Mutual Funds 1971 to 1991,” Journal of Finance, 50, 549-72. (1995)

_______ Review of Robert J. Shiller’s Irrational Exuberance, in Wall Street Journal, April 4, 2000.

Miller, Merton, Financial Innovations and Market Volatility (Blackwell: Cambridge, 1991)

Nicholson, S. F. (1960), “Price-Earnings Ratios,” Financial Analysts Journal, July/August, 43-50. (1960)

Odean, Terrance “Do Investors Trade Too Much?” American Economic Review, 89, 1279-1298. (1999)

Poterba, James and Lawrence Summers “Mean Reversion in Stock Returns: Evidence and Implications,” Journal of Financial Economics, 22, 27-60. (1988)

Rasches, Michael “Massively Confused Investors Making Conspicuously Ignorant Choices (MCI-MCIC),” Journal of Finance, 56:5, 1911-1927. (2001)

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