DP3593 Efficient Market Hypothesis and Forecasting

Author(s): Clive Granger , Allan G Timmermann

Publication Date: October 2002

Keyword(s): efficient market hypothesis , forecast evaluation , model specification , learning

JEL(s): G0

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP3593.asp

The efficient market hypothesis gives rise to forecasting tests that mirror those adopted when testing the optimality of a forecast in the context of a given information set. However, there are also important differences arising from the fact that market efficiency tests rely on establishing profitable trading opportunities in ‘real time’. Forecasters constantly search for predictable patterns and affect prices when they attempt to exploit trading opportunities. Stable forecasting patterns are therefore unlikely to persist for long periods of time and will self-destruct when discovered by a large number of investors. This gives rise to nonstationarities in the time series of financial returns and complicates both formal tests of market efficiency and the search for successful forecasting approaches.