EXAMPLE 6.32

Are stock markets efficient? The “efficient market hypothesis” for the time series of stock prices says that future stock prices (when adjusted for inflation) show only random variation. No information available now will help us predict stock prices in the future because the efficient working of the market has already incorporated all available information in the present price. Many studies have tested the claim that one or another kind of information is helpful. In these studies, the efficient market hypothesis is H₀, and the claim that prediction is possible is H_a. Almost all the studies have failed to find good evidence against H₀. As a result, the efficient market hypothesis is quite popular. But an examination of the significance tests employed finds that the power is generally low. Failure to reject H₀ when using tests of low power is not evidence that H₀ is true. As one expert says, “The widespread impression that there is strong evidence for market efficiency may be due just to a lack of appreciation of the low power of many statistical tests.”³⁰