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Efficient market hypothesis and forecasting

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  • Timmermann, Allan
  • Granger, Clive W. J.

Abstract

The efficient market hypothesis gives rise to forecasting tests that mirror those adopted when testing the optimality of a forecast in the context of a given information set. However, there are also important differences arising from the fact that market efficiency tests rely on establishing profitable trading opportunities in ‘real time’. Forecasters constantly search for predictable patterns and affect prices when they attempt to exploit trading opportunities. Stable forecasting patterns are therefore unlikely to persist for long periods of time and will self-destruct when discovered by a large number of investors. This gives rise to nonstationarities in the time series of financial returns and complicates both formal tests of market efficiency and the search for successful forecasting approaches.

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Bibliographic Info

Article provided by Elsevier in its journal International Journal of Forecasting.

Volume (Year): 20 (2004)
Issue (Month): 1 ()
Pages: 15-27

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Handle: RePEc:eee:intfor:v:20:y:2004:i:1:p:15-27

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Web page: http://www.elsevier.com/locate/ijforecast

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References

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  1. Andrew W. Lo & A. Craig MacKinlay, 1995. "Maximizing Predictability in the Stock and Bond Markets," NBER Working Papers 5027, National Bureau of Economic Research, Inc.
  2. Jensen, Michael C., 1978. "Some anomalous evidence regarding market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 95-101.
  3. Allan Timmermann & Halbert White & Ryan Sullivan, 1998. "Data-Snooping, Technical Trading, Rule Performance and the Bootstrap," FMG Discussion Papers dp303, Financial Markets Group.
  4. Bossaerts, Peter & Hillion, Pierre, 1999. "Implementing Statistical Criteria to Select Return Forecasting Models: What Do We Learn?," Review of Financial Studies, Society for Financial Studies, vol. 12(2), pages 405-28.
  5. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  6. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  7. Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-64, December.
  8. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-30, September.
  9. Allan Timmermann & M. Hashem Pesaran, 2002. "Market Timing and Return Prediction under Model Instability," FMG Discussion Papers dp412, Financial Markets Group.
  10. Black, Fischer, 1986. " Noise," Journal of Finance, American Finance Association, vol. 41(3), pages 529-43, July.
  11. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1135-45, November.
  12. Pesaran, M Hashem & Timmermann, Allan, 1995. " Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, vol. 50(4), pages 1201-28, September.
  13. Clive W.J. Granger, 1999. "Outline of forecast theory using generalized cost functions," Spanish Economic Review, Springer, vol. 1(2), pages 161-173.
  14. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, . "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 7-89, Wharton School Rodney L. White Center for Financial Research.
  15. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
  16. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
  17. Josef Lakonishok, Seymour Smidt, 1988. "Are Seasonal Anomalies Real? A Ninety-Year Perspective," Review of Financial Studies, Society for Financial Studies, vol. 1(4), pages 403-425.
  18. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
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