Download this Paper Open PDF in Browser

Predictability of Asset Returns and the Efficient Market Hypothesis

40 Pages Posted: 12 Jul 2010  

M. Hashem Pesaran

USC Dornsife Institute for New Economic Thinking; University of Southern California; Trinity College, Cambridge

Multiple version iconThere are 2 versions of this paper

Date Written: July 12, 2010


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.

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

JEL Classification: G12, G14

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:

M. Hashem Pesaran (Contact Author)

USC Dornsife Institute for New Economic Thinking ( email )

3620 S. Vermont Avenue, KAP 364F
Los Angeles, CA 90089-0253
United States

University of Southern California ( email )

Los Angeles, CA 90089
United States

Trinity College, Cambridge ( email )

United Kingdom

Paper statistics

Abstract Views