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Non-linear Error Correction and the Efficient Market Hypothesis: The Case of German Dual-Class Shares

Author

Listed:
  • Breitung Jörg

    (Humboldt University,Berlin, Germany)

  • Wulff Christian

    (PricewaterhouseCoopers,Frankfurt, Germany)

Abstract

The efficient market hypothesis implies that (risk-adjusted) asset prices cannot be cointegrated. On the other hand, arbitrage processes prevent prices of fundamentally related assets from drifting too far away. An attractive model that reconciles these two conflicting facts is the non-linear error correction mechanism (ECM). Such a process tolerates small deviations from the long-run relationship. For more substantial deviations, an effective adjustment process pushes the diverging prices towards their fundamental relationship. In this paper parametric and non-parametric techniques are employed to investigate the ECM between prices of voting and non-voting stocks. Despite its intuitive appeal, we find little evidence for a non-linear relationship between German dual-class shares. Only in four out of 12 cases does the threshold ECM yield a substantial improvement of fit. In other cases, the evidence for non-linearity is rather weak and the threshold ECM fails to outperform the linear model.

Suggested Citation

  • Breitung Jörg & Wulff Christian, 2001. "Non-linear Error Correction and the Efficient Market Hypothesis: The Case of German Dual-Class Shares," German Economic Review, De Gruyter, vol. 2(4), pages 419-434, December.
    • Handle: RePEc:bpj:germec:v:2:y:2001:i:4:p:419-434
    DOI: 10.1111/1468-0475.00047
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    1. is not listed on IDEAS
    2. Zhang, Xibin & Brooks, Robert D. & King, Maxwell L., 2009. "A Bayesian approach to bandwidth selection for multivariate kernel regression with an application to state-price density estimation," Journal of Econometrics, Elsevier, vol. 153(1), pages 21-32, November.
    3. Said M. Alkhatib, 2016. "The dynamic response patterns of output to credit: the case of Saudi Arabia," International Journal of Economics and Business Research, Inderscience Enterprises Ltd, vol. 11(1), pages 11-25.
    4. Bayer, Christian, 2008. "On the interaction of financial frictions and fixed capital adjustment costs: Evidence from a panel of German firms," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3538-3559, November.
    5. Breitung Jörg & Wulff Christian, 2001. "Non-linear Error Correction and the Efficient Market Hypothesis: The Case of German Dual-Class Shares," German Economic Review, De Gruyter, vol. 2(4), pages 419-434, December.

    More about this item

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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