Efficient Stock Markets

Abstract

This chapter is a review of the theoretical and empirical literature that studies stock market efficiency. At the outset it is important to note that any test of market efficiency is in fact a joint test of several hypotheses, i. e., tests of the efficient market hypothesis in the stock market are necessarily joint tests of an equilibrium model of expected returns and of rational processing of available information by investors. One specifies a model of equilibrium expected returns and an information set for the investors, and one postulates that economic agents set asset prices to make expected returns on assets conform to the expected values predicted by the model.¹ If the hypothesis of efficiency is rejected, it could be because the market is inefficient or because an incorrect equilibrium model has been assumed.