Fads, Martingales, and Market Efficiency

37 Pages Posted: 23 Apr 2004 Last revised: 5 Jun 2022

See all articles by Bruce N. Lehmann

Bruce N. Lehmann

University of California, San Diego; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT)

Date Written: March 1988


Much of the theoretical basis for current monetary and financial theory rests on the economic efficiency of financial markets. Not surprisingly, considerable effort has been expended to test the efficient markets hypothesis, usually by examination of the predictability of equity returns. Unfortunately, there are two competing explanations of the presence of such predictable variation: (1)market inefficiency, and stock price 'overreaction' due to speculative 'fads' and (2) predictable changes in expected security returns associated with forecasted changes in market or individual security 'fundamentals?. These explanations can be distinguished by examining equity returns over short time intervals since there should be negligible systematic changes in the fundamental valuation of individual firms over intervals like a week in an efficient market. This study finds sharp evidence of market inefficiency in the form of systematic tendencies for current 'winners' and 'losers' in one week to experience sizeable return reversals over the subsequent week in a way that reflect apparent arbitrage profits. These measured arbitrage profits persist after corrections for the mismeasurement of security returns because of thin trading and bid-ask spreads and for plausible levels of transactions costs.

Suggested Citation

Lehmann, Bruce, Fads, Martingales, and Market Efficiency (March 1988). NBER Working Paper No. w2533, Available at SSRN: https://ssrn.com/abstract=227518

Bruce Lehmann (Contact Author)

University of California, San Diego ( email )

9500 Gilman Drive
Mail Code 0502
La Jolla, CA 92093-0502
United States
858-534-0945 (Phone)
858-534-3939 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) ( email )

Cambridge, MA 02139
United States
617-253-9459 (Phone)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
PlumX Metrics