Measuring the Degree of Efficiency of Financial Market
This essay discusses first two competing hypotheses of market efficiency: the classical Efficient Market Hypothesis (EMH) of Samuelson and Fama, and the Fractal Market Hypothesis (FMH) of Mandelbrot and Peters and their weaknesses. The EMH depends on the empirically uncorroborated i.i.d. (= independence & stationarity) assumption of market innovations. The time - invariant FMH risk depends on the lengths of time horizons, as measured by the Hurst exponent. By way of empirical examples in the cash, bond and options an futures markets, it is demonstrated that scientifically a much broader concept of financial market risk is needed. This new risk concept should allow for the measurement of the degree of market efficiency, which is time and horizon dependent. The proposed definition of financial market risk is a time - frequency distribution function P, where the shape of the function is determined not only by the second-order moments σ, differentiated by the investment asset return categorizations ω, but also of the length investment horizons, or maturities of the investment securities τ, and of the time period t. In other words, the new concept of financial risk P(ω,τ,t) should be able to account for both LT and ST nonlinear time dependence and for strict non- stationarity to be empirically compatible and thus scientifically acceptable. Such a time - frequency distribution P(ω,τ,t) can be measured and identified by modern forms of time - frequency signal processing analysis, like windowed Fourier and wavelet multiresolution analysis.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Cornelis A Los, 2004. "The Unscientific Incompleteness and Bias of Unidirectional Projections (= Regressions): A Questionnaire," Econometrics 0410011, EconWPA.
- Muller, Ulrich A. & Dacorogna, Michel M. & Olsen, Richard B. & Pictet, Olivier V. & Schwarz, Matthias & Morgenegg, Claude, 1990. "Statistical study of foreign exchange rates, empirical evidence of a price change scaling law, and intraday analysis," Journal of Banking & Finance, Elsevier, vol. 14(6), pages 1189-1208, December.
- 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.
- Rendleman, Richard J, Jr & Carabini, Christopher E, 1979. "The Efficiency of the Treasury Bill Futures Market," Journal of Finance, American Finance Association, vol. 34(4), pages 895-914, September.
- Los, Cornelis A., 1999.
"Galton's Error and the under-representation of systematic risk,"
Journal of Banking & Finance,
Elsevier, vol. 23(12), pages 1793-1829, December.
- Cornelis A. Los, 2004. "Galton's Error and the Under-Representation of Systematic Risk," Finance 0409041, EconWPA.
- Figlewski, Stephen, 1989. " Options Arbitrage in Imperfect Markets," Journal of Finance, American Finance Association, vol. 44(5), pages 1289-1311, December.
- Andrew W. Lo, 1989.
"Long-term Memory in Stock Market Prices,"
NBER Working Papers
2984, National Bureau of Economic Research, Inc.
- Chang, Eric C, 1985. " Returns to Speculators and the Theory of Normal Backwardation," Journal of Finance, American Finance Association, vol. 40(1), pages 193-208, March.
- Theobald, Michael, 1981. "Beta Stationarity and Estimation Period: Some Analytical Results," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(05), pages 747-757, December.
- Harvey, Campbell R & Whaley, Robert E, 1991. " S&P 100 Index Option Volatility," Journal of Finance, American Finance Association, vol. 46(4), pages 1251-1261, September.
- Lester G. Telser, 1958. "Futures Trading and the Storage of Cotton and Wheat," Journal of Political Economy, University of Chicago Press, vol. 66, pages 233-233.
- Chen, Son-Nan, 1981. "Beta Nonstationarity, Portfolio Residual Risk and Diversification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(01), pages 95-111, March.
- Chiras, Donald P. & Manaster, Steven, 1978. "The information content of option prices and a test of market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 213-234.
- Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
- Muller, Ulrich A. & Dacorogna, Michel M. & Dave, Rakhal D. & Olsen, Richard B. & Pictet, Olivier V. & von Weizsacker, Jacob E., 1997. "Volatilities of different time resolutions -- Analyzing the dynamics of market components," Journal of Empirical Finance, Elsevier, vol. 4(2-3), pages 213-239, June.
- Black, Fischer & Scholes, Myron S, 1972. "The Valuation of Option Contracts and a Test of Market Efficiency," Journal of Finance, American Finance Association, vol. 27(2), pages 399-417, May.
- Batten, Jonathan & Ellis, Craig & Mellor, Robert, 1999. "Scaling laws in variance as a measure of long-term dependence," International Review of Financial Analysis, Elsevier, vol. 8(2), pages 123-138, June.
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpfi:0411003. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)
If references are entirely missing, you can add them using this form.