The Adaptive Market Hypothesis and Stock Return Predictability: Evidence from Major Stock Indices
29 Pages Posted: 8 Aug 2015
Date Written: August 7, 2015
This study examines the adaptive market hypothesis of the S&P500, FTSE100, NIKKEI225 and EURO STOXX 50 by testing for stock return predictability using daily data from January 1990 to May 2014. We apply three bootstrapped versions of the variance ratio test to the raw stock returns and also whiten the returns through an AR-GARCH process to study the nonlinear predictability after accounting for conditional heteroscedasticity through the BDS test. We evaluate the time-varying return predictability by applying these tests to fixed length moving subsample windows. We also examine whether there is a relationship between the level of predictability in stock returns and market conditions. The results show that there are periods of significant return predictability, but also episodes of no significant predictability in stock returns. We also find that certain market conditions are significantly related to predictability in certain markets but each market interacts differently with the different market conditions. Therefore our findings suggest that significant return predictability in stock markets does vary over time in a manner consistent with the adaptive market hypothesis and that each market adapts differently to certain market conditions.
Keywords: Adaptive market hypothesis, stock return predictability, market conditions, market efficiency
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation