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Predictability of Asset Returns and the Efficient Market Hypothesis

M. Hashem Pesaran

University of Southern California; Cambridge University - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute); Institute for the Study of Labor (IZA)

July 12, 2010

CESifo Working Paper Series No. 3116

This paper is concerned with empirical and theoretical basis of the Efficient Market Hypothesis (EMH). The paper begins with an overview of the statistical properties of asset returns at different frequencies (daily, weekly and monthly), and considers the evidence on return predictability, risk aversion and market efficiency. The paper then focuses on the theoretical foundation of the EMH, and show that market efficiency could co-exit with heterogeneous beliefs and individual irrationality so long as individual errors are cross sectionally weakly dependent in the sense defined by Chudik, Pesaran, and Tosetti (2010). But at times of market euphoria or gloom these individual errors are likely to become cross sectionally strongly dependent and the collective outcome could display significant departures from market efficiency. Market efficiency could be the norm, but it is likely to be punctuated with episodes of bubbles and crashes. The paper also considers if market inefficiencies (assuming that they exist) can be exploited for profit.

Number of Pages in PDF File: 40

Keywords: market efficiency, predictability, heterogeneity of expectations, forecast averaging, equity, premium puzzle

JEL Classification: G12, G14

working papers series

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Date posted: July 12, 2010  

Suggested Citation

Pesaran, M. Hashem, Predictability of Asset Returns and the Efficient Market Hypothesis (July 12, 2010). CESifo Working Paper Series No. 3116. Available at SSRN: http://ssrn.com/abstract=1638865

Contact Information

M. Hashem Pesaran (Contact Author)
University of Southern California ( email )
Department of Economics
3620 South Vermont Ave
Los Angeles, CA 90089-0253
United States
213 740 3510 (Phone)
Cambridge University - Faculty of Economics ( email )
Sidgwick Avenue
Cambridge CB3 9DE
United Kingdom
+44 1223 338403 (Phone)
+44 1223 335471 (Fax)
HOME PAGE: http://www.econ.cam.ac.uk/faculty/pesaran/
CESifo (Center for Economic Studies and Ifo Institute)
Poschinger Str. 5
Munich, DE-81679
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Feedback to SSRN

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