A procedure for testing the hypothesis of weak efficiency in financial markets: a Monte Carlo simulation

José A. Roldán-Casas () and B. García-Moreno García Mª ()
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José A. Roldán-Casas: University of Cordoba
B. García-Moreno García Mª: University of Cordoba

Statistical Methods & Applications, 2022, vol. 31, issue 5, No 9, 1289-1327

Abstract: Abstract The weak form of the efficient market hypothesis is identified with the conditions established by different types of random walks (1–3) on the returns associated with the prices of a financial asset. The methods traditionally applied for testing weak efficiency in a financial market as stated by the random walk model test only some necessary, but not sufficient, condition of this model. Thus, a procedure is proposed to detect if a return series associated with a given price index follows a random walk and, if so, what type it is. The procedure combines methods that test only a necessary, but not sufficient, condition for the fulfilment of the random walk hypothesis and methods that directly test a particular type of random walk. The proposed procedure is evaluated by means of a Monte Carlo experiment, and the results show that this procedure performs better (more powerful) against linear correlation-only alternatives when starting from the Ljung–Box test. On the other hand, against the random walk type 3 alternative, the procedure is more powerful when it is initiated from the BDS test.

Keywords: Efficiency; Financial markets; Random walk; Sequential testing strategy; Monte Carlo experiment; 62P20; 91G60; 60G50 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s10260-022-00627-4

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