School of Economics and Management
TECHNICAL UNIVERSITY OF LISBON
Department of Economics
Carlos Pestana Barros & Nicolas Peypoch
Maria Rosa Borges
A Comparative Analysis of Productivity Change in Italian and Portuguese Airports Efficient Market Hypothesis in European Stock Markets
ISSN Nº 0874-4548
Efficient Market Hypothesis in European Stock Markets
MARIA ROSA BORGES
Technical University of Lisbon Instituto Superior de Economia e Gestão Department of Economics
Rua Miguel Lupi, 20, 1249-078 Lisbon e-mail: firstname.lastname@example.org
Draft Version: April 2008
Efficient Market Hypothesis in European Stock Markets
This paper reports the results of tests on the weak-form market efficiency applied to stock market indexes of France, Germany, UK, Greece, Portugal and Spain, from January 1993 to December 2007. We use a serial correlation test, a runs test, an augmented Dickey-Fuller test and the multiple variance ratio test proposed by Lo and MacKinlay (1988) for the hypothesis that the stock market index follows a random walk. The tests are performed using daily and monthly data for the whole period and for the period of the last five years, i.e., 2003 to 2007. Overall, we find convincing evidence that monthly prices and returns follow random walks in all six countries. Daily returns are not normally distributed, because they are negatively skewed and leptokurtic. France, Germany, UK and Spain meet most of the criteria for a random walk behavior with daily data, but that hypothesis is rejected for Greece and Portugal, due to serial positive correlation. However, the empirical tests show that these two countries have also been approaching a random walk behavior after 2003. (JEL G14; G15)
Efficient market theory and the random walk hypothesis have been major issues in financial literature, for the past thirty years. While a random walk does not imply that a market can not be exploited by insider traders, it does imply that excess returns are not obtainable through the use of information contained in the past movement of prices. The validity of the random walk hypothesis has important implications for financial theories and investment strategies, and so this issue is relevant for academicians, investors and regulatory authorities. Academicians seek to understand the behavior of stock prices, and standard risk- return models, such as the capital asset pricing model, depend of the hypotheses of normality or random walk behavior of prices. For investors, trading strategies have to be designed taking into account if the prices are characterized by random walks or by persistence in the short run, and mean reversion in the long run. Finally, if a stock market is not efficient, the pricing mechanism does not ensure the efficient allocation of capital within an economy, with
negative effects for the overall economy. Evidence of inefficiency may lead regulatory authorities to take the necessary steps and reforms to correct it. Since the seminal work of Fama (1970), several studies show that stock price returns do not follow a random walk and are not normally distributed, including Fama and French (1988) and Lo and MacKinlay (1988), among many others. The globalization markets spawned interest on the study of this issue, with many studies both on individual markets and regional markets, such as Latin America (Urrutia 1995, Grieb and Reyes 1999), Africa (Smith at al. 2002, Magnusson and Wydick 2002), Asia (Huang 1995, Groenewold and Ariff 1998), Middle East (Abraham et al. 2002) and Europe (Worthington and...
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