The Eﬃcient Market Hypothesis: Empirical Evidence
Faculty of Economics, University of Cambridge, Cambridge, United Kingdom
Correspondence: Martin Sewell, Faculty of Economics, University of Cambridge, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom. Tel: 44-797-414-5461. E-mail: firstname.lastname@example.org Received: June 6, 2012 Accepted: August 3, 2012 Online Published: October 17, 2012
The eﬃcient market hypothesis (EMH) has been the central proposition of ﬁnance since the early 1970s and is one of the most well-studied hypotheses in all the social sciences, yet, surprisingly, there is still no consensus, even among ﬁnancial economists, as to whether the EMH holds. Five statistical analyses are conducted in an attempt to explicate such apparently contrary convictions. An analysis of daily, weekly, monthly and annual Dow Jones Industrial Average log returns found that ﬁrst-order autocorrelation is small but positive for all time periods, with the autocorrelations for daily and weekly returns closest to zero, and thus an eﬃcient market. A standard runs test showed that the hypothesis of independence is strongly rejected for daily returns, but accepted for weekly, monthly and annual returns, whilst the results of a more sophisticated runs test showed that daily, weekly and decreasing returns are the least consistent with an eﬃcient market. Rescaled range analysis was conducted on the same data sets, and there was no signiﬁcant evidence for the existence of long memory in the returns, a result consistent with market eﬃciency. Finally, from an analysis of investment newsletters it may be concluded that technical analysis— as applied by practitioners—fails to outperform the market. I reconcile the fact that daily stock market log returns pass linear statistical tests of eﬃciency, yet non-linear forecasting methods can still generate above-average riskadjusted returns, whilst discretionary technical analysts fail to make abnormal returns. Keywords: eﬃcient market hypothesis, Dow Jones Industrial Average, dependence, autocorrelation, runs test, long memory, investment newsletters 1. Introduction Just over a decade ago Mark Rubinstein published ‘Rational markets: Yes or no? The aﬃrmative case’ in the Financial Analysts Journal (Rubinstein, 2001). The current article lends empirical support to the validity of the question, and provides a more complex answer. The central paradigm in ﬁnance is the ‘eﬃcient market hypothesis’, which is covered in the following section. This paper describes ﬁve pieces of research, each of the ﬁrst four analyse daily, weekly, monthly and annual data from a major US stock market index. The ﬁrst and most straightforward test is a measurement of the autocorrelation of stock market returns. The second and third investigations involve a simple and an advanced version of the runs test (a non-parametric statistical test of the mutual dependence of the elements of a sequence). The fourth investigation tests for the existence of long memory. Finally, the ﬁfth piece of work involves an analysis of the performance of investment newsletters. All ﬁve analyses (potentially) have implications apropos market eﬃciency. 2. Eﬃcient Market Hypothesis The eﬃcient market hypothesis (EMH) has been the central proposition of ﬁnance since the early 1970s and is one of the most controversial and well-studied propositions in all the social sciences. Despite improvements in the quality and quantity of data, advances in statistical analysis and improvements in theoretical models, there is little consensus among ﬁnancial economists as to the validity of the EMH. For example, just under half of the papers reviewed in Sewell (2011) support market eﬃciency. A market is said...