A SIMPLE RETURN GENERATING MODEL IN DISCRETE TIME;
IMPLICATIONS FOR MARKET EFFICIENCY TESTING
Alexandros
E. Milionis
Bank
of Greece and University of the Aegean
Abstract
A
linear return generating model is introduced. This model is a generalization in
discrete time of the differential equation describing dynamical systems in
continuous time. The model is useful in its own right, as it provides a
simplified, yet credible, quantitative description of the reality. Further, the
model is used as a tool for a theoretical study of market efficiency testing. This is obtained by modelling certain market conditions under which new information
is released and reflected in asset prices on the one hand, and, on the other
hand, by recording what established econometric testing approaches conclude, about
the hypothesis of market efficiency. Amongst others it is argued that, contrary
to the general belief, theoretically a random walk in asset prices, under
certain conditions, could be associated with profoundly inefficient markets. Furthermore,
an enhancement of the battery of statistical tests for market efficiency is
proposed by the potential application of specific forms of the suggested linear
dynamic model and the possible advantages over the existing techniques are
discussed.
Keywords: Market Efficiency Testing,
Random Walks, Return Generating Model, Return Predictability.
JEL Classification: G14, G15
Acknowledgements: The author
is grateful to H. Gibson and the referee for helpful comments. The views
expressed in the paper are those of the author and do not necessarily reflect
those of the Bank of Greece.
Correspondence:
Alexandros E. Milionis
Bank of Greece,
Department of Statistics
21 E. Venizelos Avenue,
Athens GR 102 50
e-mail: amilionis@bankofgreece.gr