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EMH

Efficient Markets Hypothesis: Introduction


Markets
Whenever there are valuable commodities to be traded, there are incentives to
develop a social arrangement that allows buyers and sellers to discover
information and carry out a voluntary exchange more efficiently, i.e. develop a
market. The largest and best organised markets in the world tend to be the
securities markets.

Efficiency in Economics
The concept of efficiency in economics is a general term for the value assigned
to a situation by some measure designed to capture the amount of waste or
friction or other undesirable economic features present. Within this context,
it has several quite distinct meanings. For example, allocative efficiency is
concerned with the optimal distribution of scarce resources among individuals
in the economy. An efficient portfolio is one with the highest expected return
for a given level of risk. An efficient market is one in which information is
rapidly disseminated and reflected in prices.

Important
The EMH has been the central proposition of finance since the early 1970s and
is one of the most contoversial and well-studied propositions in all the social
sciences.

History
The history of the EMH is covered in detail here, Bachelier (1900), Samuelson
(1965) and Fama (1970) being the most important papers.

Definition
The term efficient market was first introduced into the economics literature
by Fama in 1965. For this and subsequent definitions, see here.

Scope
The term efficient market was initially applied to the stock market, but the
concept was soon generalised to other asset markets.

Starting Point
Regardless of whether or not one believes that markets are efficient, or even
whether they are efficient, the efficient market hypothesis is almost certainly
the right place to start when thinking about asset price formation. One can
then consider relative efficiency.

Two informal explanations for market efficiency


If one could be sure that a price will rise tomorrow, the asset would be bought
today, raising the price, so that it will not, in fact rise tomorrow. Ergo, the
price is unpredictable.

The intrinsic value of an asset is implied by the cumulative impact of


information we receive as news. Successive news items must be random
because if an item of news were not random, that is, if it were dependent on an
earlier item of news, then it wouldn't be news at all. After all, news by
definition is new. If the rapidly price reflects all information (i.e. the market
is efficient), then the price will fluctuate randomly.

Academics Versus Practitioners


There is little consensus between the opinions held in academia and industry.
Unsurprisingly, most of the support for the EMH comes from the former.

Major Contributor Unrecognised


The American astrophysicist, M. F. Maury Osborne, was the first to publish
the hypothesis that price follows a geometric Brownian motion (the
distribution of price changes is log normal) (Osborne 1959), and was jointly
responsible for the earliest literature identifying the fat tails (Osborne 1959),
that price deviation is proportional to the square root of time (Osborne 1959)
and nonstationarity (Osborne 1962).

Joke
There is an old joke, widely told among economists, about an economist
strolling down the street with a companion when they come upon a $100 bill
lying on the ground. As the companion reaches down to pick it up, the
economist says Dont bother if it were a real $100 bill, someone would have
already picked it up.
Lo in Lo (1997)

Rational?
Contrary to popular belief, the EMH does not require that all market
participants are rational. Indeed, markets can be efficient even when a group
of investors are irrational and correlated, so long as there are some rational
traders present together with arbitrage opportunities. See Shleifer (2000).

Not Possible
Grossman and Stiglitz (1980) argued that because information is costly, prices
cannot perfectly reflect the information which is available, since if it did, those
who spent resources to obtain it would receive no compensation, leading to
the conclusion that an informationally efficient market is impossible.
See impossible.

Not Refutable
The EMH, by itself, is not a well-defined and empirically refutable hypothesis.
See here.

Conclusion
"I believe there is no other proposition in economics which has more solid
empirical evidence supporting it than the Efficient Market Hypothesis."
Jensen (1978)

"If the efficient markets hypothesis was a publicly traded security, its price
would be enormously volatile."
Shleifer and Summers (1990)

"It is disarmingly simple to state, has far-reaching consequences for academic


pursuits and business practice, and yet is surprisingly resilient to empirical
proof or refutation."
Lo in Lo (1997)

"Market efficiency survives the challenge from the literature on long-term


return anomalies. Consistent with the market efficiency hypothesis that the
anomalies are chance results, apparent overreaction to information is about as
common as underreaction, and post-event continuation of pre-event abnormal
returns is about as frequent as post-event reversal. Most important, consistent
with the market efficiency prediction that apparent anomalies can be due to
methodology, most long-term return anomalies tend to disappear with
reasonable changes in technique."
Fama (1998)

"What, then, can we conclude about market efficiency? Amazingly, there is


still no consensus among financial economists. Despite the many advances in
the statistical analysis, databases and theoretical models surrounding the
efficient markets hypothesis, the main effect has been to harden the resolve of
the proponents on each side of the debate."
Lo (2000) in Cootner (1964)

Best Paper
Fama (1970).

Best book
"The Econometrics of Financial Markets" by Campbell, Lo and Mackinlay
(1997).

Review/Survey Papers
Fama (1970)

Fama (1991)

Dimson and Mussavian (1998)

Fama (1998)

Farmer and Lo (1999)

Beechey, Vickery and Gruen (2000)

Lo (2000)
Andreou, Pittis and Spanos (2001)

EMH Definitions
(Or moving goalposts?)
Fama (Jan. 1965: The behavior of stock-market prices):
an efficient market for securities, that is, a market where, given the
available information, actual prices at every point in time represent very good
estimates of intrinsic values.

Fama (Sep.Oct. 1965: Random walks in stock market prices):


An efficient market is defined as a market where there are large numbers of
rational, profit-maximizers actively competing, with each trying to predict
future market values of individual securities, and where important current
information is almost freely available to all participants.

Fama et al. (1969):


an efficient market, i.e., a market that adjusts rapidly to new information.

Fama (1970):
A market in which prices always fully reflect available information is called
efficient.

Jensen (1978):
A market is efficient with respect to information set t if it is impossible to
make economic profits by trading on the basis of information set t.
[By economic profits, we mean the risk adjusted returns net of all costs.]

Fama (1991):
I take the market efficiency hypothesis to be the simple statement that
security prices fully reflect all available information. A precondition for this
strong version of the hypothesis is that information and trading costs, the
costs of getting prices to reflect information, are always 0 (Grossman and
Stiglitz (1980)). A weaker and economically more sensible version of the
efficiency hypothesis says that prices reflect information to the point where
the marginal benefits of acting on information (the profits to be made) do not
exceed marginal costs (Jensen (1978)).
Malkiel (1992):
A capital market is said to be efficient if it fully and correctly reflects all
relevant information in determining security prices. Formally, the market is
said to be efficient with respect to some information set, , if security prices
would be unaffected by revealing that information to all participants.
Moreover, efficiency with respect to an information set, , implies that it is
impossible to make economic profits by trading on the basis of .

Fama (1998):
market efficiency (the hypothesis that prices fully reflect available
information)...
the simple market efficiency story; that is, the expected value of abnormal
returns is zero, but chance generates deviations from zero (anomalies) in both
directions.

Timmermann and Granger (2004):


A market is efficient with respect to the information set, t, search
technologies, St, and forecasting models, Mt, if it is impossible to make
economic profits by trading on the basis of signals produced from a
forecasting model in Mt defined over predictor variables in the information
set t and selected using a search technology in St.

Efficient Markets Hypothesis: History

SEWELL, Martin, 2011. History of the efficient market hypothesis. Research


Note RN/11/04, University College London, London.

Year
1565 The prominent Italian mathematician, Girolamo Cardano,
in Liber de Ludo Aleae (The Book of Games of Chance)
wrote: The most fundamental principle of all in gambling is
simply equal conditions, e.g. of opponents, of bystanders, of
money, of situation, of the dice box, and of the die itself. To
the extent to which you depart from that equality, if it is in
your opponents favour, you are a fool, and if in your own,
you are unjust.
1828 Scottish botanist, Robert Brown, noticed that grains of pollen
suspended in water had a rapid oscillatory motion when
viewed under a microscope.

1863 A French stockbroker, Jules Regnault, observed that the


longer you hold a security, the more you can win or lose on
its price variations: the price deviation is directly
proportional to the square root of time.

1876 Samuel Benner, an Ohio farmer, authored Benners


Prophecies of Future Ups and Downs in Prices in which he
wrote The price of any product is the exponent of the
accumulated wisdom of the country in regard to the
available supply and prospective demand for that product...
Thanks to Chris Dennistoun for this reference.

1880 The British physicist, Lord Rayleigh, (through his work on


sound vibrations) is aware of the notion of a random walk.

1888 John Venn, the British logician and philosopher, had a clear
concept of both random walk and Brownian motion.

1889 Efficient markets were clearly mentioned in a book by


George Gibson entitled The Stock Markets of London, Paris
and New York. Gibson wrote that when shares become
publicly known in an open market, the value which they
acquire may be regarded as the judgment of the best
intelligence concerning them.

1890 Alfred Marshall wrote Principles of Economics.

1900 A French mathematician, Louis Bachelier, published his PhD


thesis, Thorie de la spculation. He developed the
mathematics and statistics of Brownian motion five years
before Einstein (1905). He also deduced that The
mathematical expectation of the speculator is zero 65 years
before Samuelson (1965) explained efficient markets in
terms of a martingale. Bacheliers work was way ahead of his
time and was ignored until it was rediscovered by Savage in
1955.

1901

1902

1903

1904

1905 Karl Pearson, a professor and Fellow of the Royal Society,


introduced the term random walk in the letters pages
of Nature.

Unaware of Bacheliers work in 1900, Albert Einstein


developed the equations for Brownian motion.

1906 Bachelier

A Polish scientist, Marian Smoluchowski, described Brownian


motion.

1907

1908 Bacheliers arguments can also be found in Andr Barriols


book on financial transactions.

De Montessus published a book on probability and its


applications, which contains a chapter on finance based on
Bachelier's thesis.

Langevin authors the stochastic differential equation of


Brownian motion.

1909

1910

1911

1912 George Binney Dibblee published The laws of supply and


demand.
1913

1914 Bachelier published the book, Le Jeu, la Chance et le


Hasard (The Game, the Chance and the Hazard), which sold
over six thousand copies.

1915 According to Mandelbrot (1963) the first to note that


distributions of price changes are too peaked to be relative
to samples from Gaussian populations was Wesley C.
Mitchell.

1916

1917

1918

1919

1920

1921 F. W. Taussig published a paper under the title, Is Market


Price Determinate?

1922

1923 Keynes clearly stated that investors on financial markets are


rewarded not for knowing better than the market what the
future has in store, but rather for risk baring, this is a
consequence of the EMH.

1924

1925 Frederick MacCauley, an economist, observed that there was


a striking similarity between the fluctuations of the stock
market and those of a chance curve which may be obtained
by throwing a dice.

1926 Unquestionable proof of the leptokurtic nature of the


distribution of returns was given by Maurice Olivier in his
Paris doctoral dissertation.
1927 Frederick C. Mills, in The Behavior of Prices, proved the
leptokurtosis of returns.

1928

1929 Stock-market crash in late October.

1930 Alfred Cowles, the American economist and businessman,


founded and funded both the Econometric Society and its
journal, Econometrica.

1931

1932 Cowles set up the Cowles Commission for Economic


Research.

1933 Alfred Cowles 3rd analysed the performance of investment


professionals and concluded that stock market forecasters
cannot forecast.

1934 Holbrook Working concludes that stock returns behave like


numbers from a lottery.

1935

1936 English economist, John Maynard Keynes has General Theory


of Employment, Interest, and Money published. He famously
compares the stock market with a beauty contest, and also
claims that most investors decisions can only be as a result
of animal spirits.

1937 Eugen Slutzky shows that sums of independent random


variables may be the source of cyclic processes.

In the only paper published before 1960 which found


significant inefficiencies, Cowles and Jones found significant
evidence of serial correlation in averaged time series indices
of stock prices.

1938
1939

1940

1941

1942

1943

1944 In a continuation of his 1933 publication, Cowles again


reported that investment professionals do not beat the
market.

1945

1946

1947

1948

1949 Holbrook Working showed that in an ideal futures market it


would be impossible for any professional forecaster to
predict price changes successfully.

1950

1951

1952

1953 Milton Friedman points out that, due to arbitrage, the case
for the EMH can be made even in situations where the
trading strategies of investors are correlated.

Kendall analysed 22 price-series at weekly intervals and


found to his surprise that they were essentially random. Also,
he was the first to note the time dependence of the
empirical variance (nonstationarity).

1954
1955 Around this time, Leonard Jimmie Savage, who had
discovered Bacheliers 1914 publication in the Chicago or
Yale library sent half a dozen blue ditto postcards to
colleagues, asking does any one of you know him? Paul
Samuelson was one of the recipients. He couldn't find the
book in the MIT library, but he did discover a copy of
Bacheliers Ph.D. thesis.

1956 Bacheliers name reappeared in economics, this time, as an


acknowledged forerunner, in a thesis on options-like pricing
by a student of MIT economist Paul A. Samuelson.

1957

1958 Working builds an anticipatory market model.

1959 Harry Roberts demonstrates that a random walk will look


very much like an actual stock series.

M. F. M. Osborne shows that the logarithm of common-stock


prices follows Brownian motion; and also found evidence of
the square root of time rule. Regarding the distribution of
returns, he finds a larger tangential dispersion in the data
at these limits.

1960 Larson presents the results of application of a new method of


time-series analysis. He notes that the distribution of price
changes is "very nearly normally distributed for the central
80 per cent of the data, but there is an excessive number of
extreme values."

Cowles revisits the results in Cowles and Jones (1937),


correcting an error introduced by averaging, and still finds
mixed temporal dependence results.

Working showed that the use of averages can introduce


serial correlations not present in the original series.

1961 Houthakker uses stop-loss sell orders and finds patterns. He


also finds leptokurtosis, nonstationarity and suspects
nonlinearity.

Independently of Working (1960), Alexander realised that


spurious autocorrelation could be introduced by averaging;
or if the probability of a rise is not 0.5. He concluded that the
random walk model best fits the data, but found
leptokurtosis in the distribution of returns. Also, this paper
was the first to test for nonlinear dependence.

John F. Muth introduces the rational expectations hypothesis


in economics.

1962 Mandelbrot first proposes that the tails follow a power law, in
IBM Research Note NC-87.

Paul H. Cootner concludes that the stock market is not a


random walk.

Osborne investigates deviations of stock prices from a


simple random walk, and his results include the fact that
stocks tend to be traded in concentrated bursts.

Arnold B. Moore found insignificant negative serial


correlation of the returns of individual stocks, but a slight
positive serial correlation for the index.

Jack Treynors unpublished manuscript: Toward a Theory of


Market Value of Risky Assets

1963 Berger and Mandelbrot propose a new model for error


clustering in telephone circuits, and if their argument is
applicable to stock trading, it might afford justification for
the Pareto-Levy distribution of stock price changes claimed
by Mandelbrot.

Granger and Morgenstern perform spectral analysis on


market prices and found that short-run movements of the
series obey the simple random walk hypothesis, but that
long-run movements do not, and that business cycles were
of little or no importance.
Benoit Mandelbrot presents and tests a new model of price
behaviour. Unlike Bachelier, he uses natural logarithms of
prices and also replaces the Gaussian distributions with the
more general stable Paretian.

Fama discusses Mandelbrots stable Paretian hypothesis


and concludes that the tested market data conforms to the
distribution.

1964 Alexander answers the critics of his 1961 paper and


concludes that the S&P industrials does not follow a random
walk.

Cootner edited his classic book, The Random Character of


Stock Market Prices, a collection of papers by Roberts,
Bachelier, Cootner, Kendall, Osborne, Working, Cowles,
Moore, Granger and Morgenstern, Alexander, Larson,
Steiger, Fama, Mandelbrot and others.

Godfrey, Granger and Morgenstern publish The Random


Walk Hypothesis of Stock Market Behavior.

Steiger tests for nonrandomness and concludes that stock


prices do not follow a random walk.

Sharpes Nobel prize winning work on the Capital Asset


Pricing Model.

1965 Fama defines an efficient market for the first time, in his
landmark empirical analysis of stock market prices that
concluded that they follow a random walk.

Samuelson provided the first formal economic argument for


efficient markets. His contribution is neatly summarized by
the title of his article: Proof that Properly Anticipated Prices
Fluctuate Randomly. He (correctly) focussed on the concept
of a martingale, rather than a random walk (as in Fama
(1965)).

Fama explains how the theory of random walks in stock


market prices presents important challenges to both the
chartist and the proponent of fundamenatl analysis.

1966 Fama and Blume concluded that for measuring the direction
and degree of dependence in price changes, serial
correlation is probably as powerful as the Alexandrian filter
rules.

Mandelbrot proved some of the first theorems showing how,


in competitive markets with rational risk-neutral investors,
returns are unpredictablesecurity values and prices follow
a martingale.

1967 Harry Roberts coined the term efficient markets hypothesis


and made the distinction between weak and strong form
tests, which became the classic taxonomy in Fama (1970).

1968 Ball and Brown were the first to publish an event study.

Michael C. Jensen evaluates the performance of mutual


funds and concludes that on average the funds apparently
were not quite successful enough in their trading activities to
recoup even their brokerage expenses.

1969 Fama, Fisher, Jensen and Roll undertook the first ever event
study, and their results lend considerable support to the
conclusion that the stock market is efficient.

1970 The definitive paper on the efficient markets hypothesis is


Eugene F. Famas first of three review papers: Efficient
Capital Markets: A Review of Theory and Empirical Work. He
defines an efficient market thus: A market in which prices
always fully reflect available information is called
efficient.. He was also the first to consider the joint
hypothesis problem.

Granger and Morgenstern publish the book The Predictability


of Stock Market Prices.

1971 Kemp and Reid concluded that share price movements were
conspicuously non-random.

Jack L. Treynor published The Only Game in Town under the


pseudonym Walter Bagehot.

Hirshleifer first noted that the expected revelation of


information can prevent risk sharing.

1972 Scholes studies the price effects of secondary offerings and


finds that the market is efficient except for some indication
of post-event price drift.

1973 Samuelsons survey paper, Mathematics of Speculative


Price.

LeRoy showed that under risk-aversion, there is no


theoretical justification for the martingale property.

Lorie and Hamilton publish the book The Stock Market:


Theories and Evidence.

Burton G. Malkiel first publishes the classic A Random Walk


Down Wall Street.

Samuelson generalized his earlier (1965) work to include


stocks that pay dividends.

1974

1975

1976 Cox and Ross author The Valuation of Options for


Alternative Stochastic Processes.

Sanford Grossman describes a model which shows that


informationally efficient price systems aggregate diverse
information perfectly, but in doing this the price system
eliminates the private incentive for collecting the
information.

Fama publishes the book Foundations of Finance.


1977 Beja showed that the efficiency of a real market is
impossible.

1978 Ball wrote a survey paper which revealed consistent excess


returns after public announcements of firms' earnings.

Jensen famously wrote, I believe there is no other


proposition in economics which has more solid empirical
evidence supporting it than the Efficient Market Hypothesis.
He defines efficiency thus: A market is efficient with respect
to information set t if it is impossible to make economic
profits by trading on the basis of information set t.

Robert E. Lucas, Jr. builds a theoretical model of rational


agents which shows that the Martingale property need not
hold under risk aversion.

1979 With a theoretical model, Radner shows when rational


expectations equilibria exist that reveal to all traders all of
their initial information.

Dimson reviews the problems of risk measurement


(estimating beta) when shares are subject to infrequent
trading.

Harrison and Kreps publish Martingales and Arbitrage in


Multiperiod Securities Markets.

Robert J. Shiller shows that the volatility of long-term interest


rates is greater than predicted.

1980 Sanford J. Grossman and Joseph E. Stiglitz show that it is


impossible for a market to be perfectly informationally
efficient. Because information is costly, prices cannot
perfectly reflect the information which is available, since if it
did, investors who spent resources on obtaining and
analyzing it would receive no compensation. Thus, a sensible
model of market equilibrium must leave some incentive for
information-gathering (security analysis).
1981 LeRoy and Porter show excess volatility and market
efficiency is rejected.

Stiglitz shows that even with apparently competitive and


efficient markets, resource allocations may not be Pareto
efficient.

Shiller shows that stock prices move too much to be justified


by subsequent changes in dividends, i.e. excess volatility.

1982 Milgrom and Stokey show that under certain conditions, the
receipt of private information cannot create any incentives
to trade.

Tirole shows that unless traders have different priors or are


able to obtain insurance in the market, speculation relies on
inconsistent plans, and thus is ruled out by rational
expectations.

1983

1984 Osborne and Murphy find evidence of the square root of time
rule in earnings.

Roll examined US orange juice futures prices and the effect


of the weather. He found excess volatility.

1985 Werner F. M. DeBondt and Richard Thaler discovered that


stock prices overreact; evidencing substantial weak form
market inefficiencies. This paper marked the start of
behavioural finance.

1986 Marsh and Merton analyze the variance-bound methodology


used by Shiller and conclude that this approach cannot be
used to test the hypothesis of stock market rationality. They
also highlight the practical consequences of rejecting the
EMH.

Fischer Black introduces the concept of noise traders, those


who trade on anything other than information, and shows
that noise trading is essential to the existence of liquid
markets.

Lawrence H. Summers argues that many statistical tests of


market efficiency have very low power in discriminating
against plausible forms of inefficiency.

French and Roll found that asset prices are much more
volatile during exchange trading hours than during non-
trading hours; and they deduced that this is due to trading
on private informationthe market generates its own news.

1987

1988 Fama and French found large negative autocorrelations for


stock portfolio return horizons beyond a year.

Lo and MacKinlay strongly rejected the random walk


hypothesis for weekly stock market returns using the
variance-ratio test.

Poterba and Summers show that stock returns show positive


autocorrelation over short periods and negative
autocorrelation over longer horizons.

Conrad and Kaul characterize the stochastic behavior of


expected returns on common stock.

1989 Cutler, Poterba and Summers found that news does not
adequately explain market movement.

Eun and Shim found that a substantial amount of


interdependence exists among national stock markets, and
the results are consistent with informationally efficient
international stock markets.

Ball discusses the specification of stock market efficiency.

Guimaraes, Kingsman and Taylor edit the book A Reappraisal


of the Efficiency of Financial Markets.

LeRoy publishes his survey paper, Efficient Capital Markets


and Martingales. He makes it clear that the transition
between the intuitive idea of market efficiency and the
martingale is far from direct.

Shiller publishes Market Volatility, a book about the sources


of volatility which challenges the EMH.

1990 Laffont and Maskin show that the efficient market hypothesis
may well fail if there is imperfect competition.

Lehmann finds reversals in weekly security returns and


rejects the efficient markets hypothesis.

Jegadeesh documents strong evidence of predictable


behavior of security returns and rejects the random walk
hypothesis.

1991 Kim, Nelson and Startz reexamine the empirical evidence for
mean-reverting behaviour in stock prices and find that mean
reversion is entirely a pre-World War II phenomenon.

Matthew Jackson explicitly models the price formation


process and shows that if agents are not price-takers, then it
is possible to have an equilibrium with fully revealing prices
and costly information acquisition.

Andrew W. Lo developed a test for long-run memory that is


robust to short-range dependence, and concludes that there
is no evidence of long-range dependence in any of the stock
returns indexes tested.

The second of Famas three review papers. Instead of weak-


form tests, the first category now covers the more general
area of tests for return predictability.

1992 Chopra, Lakonishok and Ritter find that stocks overreact.

Bekaert and Hodrick characterize predictable components in


excess returns on equity and foreign exchange markets.

Peter L. Bernstein publishes the book Capital Ideas, an


engaging account of the history of the ideas that shaped
modern finance and laced with anecdotes.

Malkiels essay Efficient Market Hypothesis in the New


Palgrave Dictionary of Money and Finance.

1993 Jegadeesh and Titman found that trading strategies that


bought past winners and sold past losers realized significant
abnormal returns.

Richardson shows that the patterns in serial-correlation


estimates and their magnitude observed in previous studies
should be expected under the null hypothesis of serial
independence.

1994 Roll observes that in practice it is hard to profit from even


the strongest market inefficiencies.

Huang and Stoll provide new evidence concerning market


microstructure and stock return predictions.

Metcalf and Malkiel find that portfolios of stocks chosen by


experts do not consistently beat the market.

Lakonishok, Shleifer and Vishny provide evidence that value


strategies yield higher returns because these strategies
exploit the suboptimal behavior of the typical investor and
not because these strategies are fundamentally riskier.

1995 Haugen publishes the book The New Finance: The Case
Against Efficient Markets. He emphasizes that short-run
overreaction (which causes momentum in prices) may lead
to long-term reversals (when the market recognizes its past
error).

1996 W. Brian Arthur, et al. propose a theory of asset pricing by


creating an artificial stock market with heterogeneous
agents with endogenous expectations.

Campbell, Lo and MacKinlay publish their seminal book on


empirical finance, The Econometrics of Financial Markets.

Chan, Jegadeesh and Lakonishok look at momentum


strategies and their results suggest a market that responds
only gradually to new information.

1997 Andrew Lo edits two volumes that bring together the most
influential articles on the EMH.

Chan, Gup and Pan conclude that the world equity markets
are weak-form efficient.

Dow and Gorton investigate the connection between stock


market efficiency and economic efficiency.

1998 Elroy Dimson and Massoud Mussavian give a brief history of


market efficiency.

In his third of three reviews, Fama concludes that, Market


efficiency survives the challenge from the literature on long-
term return anomalies.

1999 Lo and MacKinlay publish A Non-Random Walk Down Wall


Street.

Bernstein criticizes the EMH and claims that the marginal


benefits of investors acting on information exceed the
marginal costs.

Zhang presents a theory of marginally efficient markets.

Farmer and Lo publish an excellent but brief review article.

2000 Shleifer publishes Inefficient Markets: An Introduction to


Behavioral Finance, which questions the assumptions of
investor rationality and perfect arbitrage.

Lo publishes a selective survey of finance.

Beechey, Vickery and Gruens survey paper.

Shiller publishes the first edition of Irrational Exuberance,


which challenges the EMH, demonstrating that markets
cannot be explained historically by the movement of
company earnings or dividends.

2001 Eugene Fama became the first elected fellow of the


American Finance Association.

In an excellent historical review paper, Andreou, Pittis and


Spanos trace the development of various statistical models
proposed since Bachelier (1900), in an attempt to assess
how well these models capture the empirical regularities
exhibited by data on speculative prices.

Mark Rubinstein reexamines some of the most serious


historical evidence against market rationality and concludes
that markets are rational.

Shafer and Vovk publish Probability and Finance: Its Only a


Game! which shows how probability can be based on game
theory; they then apply the framework to finance.

2002 Lewellen and Shanken conclude that parameter uncertainty


can be important for characterizing and testing market
efficiency.

Chen and Yeh investigate the emergent properties of


artificial stock markets and show that the EMH can be
satisfied with some portions of the artificial time series.

2003 Malkiel examines the attacks on the EHM and concludes that
our stock markets are far more efficient and far less
predictable than some recent academic papers would have
us believe.

G. William Schwert shows that when anomalies are


published, practitioners implement strategies implied by the
papers and the anomalies subsequently weaken or
disappear. In other words, research findings cause the
market to become more efficient.
2004 Timmermann and Granger discuss the EMH from the
perspective of a modern forecasting approach.

2005 Malkiel shows that professional investment managers do not


outperform their index benchmarks and provides evidence
that by and large market prices do seem to reflect all
available information.

2006 Blakey looked at some of the causes and consequences of


random price behaviour.

Tth and Kertsz found evidence of increasing efficiency in


the New York Stock Exchange.

Home

EMH Taxonomy
The classic taxonomy of information sets, due to Roberts (1967), and used by
Fama (1970) includes the following:

Weak Form Efficiency


The information set includes only the history of prices.

Semi-strong Form Efficiency


The information set includes all information known to all market participants
(publicly available information).

Strong Form Efficiency


The information set includes all information known to any market participant
(private information).

Redefined by Fama (1991):

"The 1970 review divides work on market efficiency into three categories: (1)
weak-form (How well do past returns predict future returns?), (2) semi-
strong-form tests (How quickly do security prices reflect public information
announcements?), and (3) strong-form tests (Do any investors have private
information that is not fully reflected in market prices?) At the risk of
damning a good thing, I change the categories in this paper.
Instead of weak-form tests, which are only concerned with the forecast power
of past returns, the first category now covers the more general area oftests for
return predictability, which also includes the burgeoning work on forecasting
returns with variables like dividend yields and interest rates. Since market
efficiency and equilibrium-pricing issues are inseparable, the discussion of
predictability also considers the cross-sectional predictability of returns, that
is, tests of asset-pricing models and the anomalies (like the size effect)
discovered in the tests. Finally, the evidence that there are seasonals in returns
(like the January effect), and the claim that security prices are too volatile are
also considered, but only briefly, under the rubric of return predictability.

For the second and third categories, I propose xchanges in title, not coverage.
Instead of semi-strog-form tests of the adjustment of prices to public
announcements, I use the now common title, event studies. Instead of strong-
form tests of whether specific investors have information not in market prices,
I suggest the more descriptive title, tests for private information."

Random Walk Hypothesis

SEWELL, Martin, 2011. Characterization of financial time series. Research


Note RN/11/01, University College London, London.

Applicabilit
Stochastic Descriptio
y to real Notes
process n
markets

Regnault (1863) and


Osborne (1959)
discovered that price
deviation is proportional
to the square root of
satisfies the time, but the
diffusion
diffusion poor nonstationarity found by
process
equation Kendall (1953),
Houthakker (1961) and
Osborne (1962)
compromises the
significance of the
process.

Gaussian increments poor Financial markets exhibit


leptokurtosis (Mitchell
(1915, 1921), Olivier
normally (1926), Mills (1927),
process
distributed Osborne (1959), Larson
(1960), Alexander
(1961)).

Kendall (1953),
Houthakker (1961) and
stationary Osborne (1962) found
independen nonstationarities in
Lvy process poor
t markets in the form of
increments positive autocorrelation
in the variance of
returns.

Kendall (1953),
Houthakker (1961) and
Osborne (1962) found
Markov process memoryless poor
positive autocorrelation
in the variance of
returns.

martingale zero submartingal Bachelier (1900) and


expected e: good for Samuelson (1965)
return stock market recognised the
importance of the
martingale in relation to
an efficient market.
Whilst Cox and Ross
(1976), Lucas (1978) and
Harrison and Kreps
(1979) pointed out that in
practice investors are risk
averse, so (presumably
as compensation for the
time value of money and
systematic risk) they
demand a positive
expected return. In a
long-only market like a
stock market this implies
that the price of a stock
follows a submartingale
(a martingale being a
special case when
investors are risk-
neutral).

LeRoy (1973) and


discrete (especially) Lucas (1978)
version of pointed out that a
random walk poor
Brownian random walk is neither
motion necessary nor sufficient
for an efficient market.

Wiener continuous- poor Bachelier (1900)


process/Browni time, developed the
an motion Gaussian mathematics of Brownian
independen motion and used it to
t model financial markets.
increments Note that Brownian
motion is a diffusion
process, a Gaussian
process, a Lvy process,
a Markov process and a
martingale. On the one
hand this makes it a very
strong condition (and
therefore the least
realistic), on the other
hand it makes it a very
important generic
stochastic process and is
therefore used
extensively for modelling
financial markets (for
example, see Black and
Scholes (1973)).

Note that above we are interested in the logarithm of the price of an asset
(Osborne (1959)).

Efficient Markets Hypothesis: Joint Hypothesis

Important paper: Fama (1970)

An efficient market will always fully reflect available information, but in


order to determine how the market should fully reflect this information, we
need to determine investors risk preferences. Therefore, any test of the EMH
is a test of both market efficiency and investors risk preferences. For this
reason, the EMH, by itself, is not a well-defined and empirically refutable
hypothesis.
Sewell (2006)

"First, any test of efficiency must assume an equilibrium model that defines
normal security returns. If efficiency is rejected, this could be because the
market is truly inefficient or because an incorrect equilibrium model has been
assumed. This joint hypothesis problem means that market efficiency as such
can never be rejected."
Campbell, Lo and MacKinlay (1997), page 24

"...any test of the EMH is a joint test of an equilibrium returns model and
rational expectations (RE)."
Cuthbertson (1996)

"The notion of market efficiency is not a well-posed and empirically refutable


hypothesis. To make it operational, one must specify additional structure, e.g.,
investors preferences, information structure, etc. But then a test of market
efficiency becomes a test of several auxiliary hypotheses as well, and a
rejection of such a joint hypothesis tells us little about which aspect of the
joint hypothesis is inconsistent with the data."
Lo (2000) in Cootner (1964), page x

One of the reasons for this state of affairs is the fact that the EMH, by itself, is
not a well-defined and empirically refutable hypothesis. To make it
operational, one must specify additional structure, e.g. investors' preferences,
information structure. But then a test of the EMH becomes a test of several
auxiliary hypotheses as well, and a rejection of such a joint hypothesis tells us
little about which aspect of the joint hypothesis is inconsistent with the data.
Are stock prices too volatile because markets are inefficient, or is it due to risk
aversion, or dividend smoothing? All three inferences are consistent with the
data. Moreover, new statistical tests designed to distinguish among them will
no doubt require auxiliary hypotheses of their own which, in turn, may be
questioned."
Lo in Lo (1997), page xvii

"For the CAPM or the multifactor APT to be true, markets must be efficient."
"Asset-pricing models need the EMT. However, the notion of an efficient
market is not affected by whether any particular asset-pricing theory is true. If
investors preferred stocks with a high unsystematic risk, that would be fine: as
long as all information was immediately reflected in prices, the EMT theory
would be true."
Lofthouse (2001), page 91

"One of the reasons for this state of affairs is the fact that the Efficient Markets
Hypothesis, by itself, is not a well-defined and empirically refutable
hypothesis. To make it operational, one must specify additional structure, e.g.,
investor preferences, information structure, business conditions, etc. But then
a test of the Efficient Markets Hypothesis becomes a test of several auxiliary
hypotheses as well, and a rejection of such a joint hypothesis tells us little
about which aspect of the joint hypothesis is inconsistent with the data. Are
stock prices too volatile because markets are inefficient, or is it due to risk
aversion, or dividend smoothing? All three inferences are consistent with the
data. Moreover, new statistical tests designed to distinguish among them will
no doubt require auxiliary hypotheses of their own which, in turn, may be
questioned."
Lo and MacKinlay (1999), pages 6-7

Efficient Markets Hypothesis: Impossible

Grossman and Stiglitz (1980) argued that because information is costly, prices
cannot perfectly reflect the information which is available, since if it did, those
who spent resources to obtain it would receive no compensation, leading to
the conclusion that an informationally efficient market is impossible.
Sewell (2006)
"Second, perfect efficiency is an unrealistic benchmark that is unlikely to hold
in practice. Even in theory, as Grossman and Stiglitz (1980) have shown,
abnormal returns will exist if there are costs of gathering and processing
information. These returns are necessary to compensate investors for their
information-gathering and information-processing expenses, and are no
longer abnormal when these expenses are properly accounted for. In a large
and liquid market, information costs are likely to justify only small abnormal
returns, but it is difficult to say how small, even if such costs could be
measured precisely."
Campbell, Lo and MacKinlay (1997), page 24

"Grossman (1976) and Grossman and Stiglitz (1980) go even further. They
argue that perfectly informationally efficient markets are an impossibility, for
if markets are perfectly efficient, the return to gathering information is nil, in
which case there would be little reason to trade and markets would eventually
collapse. Alternatively, the degree of market inefficiency determines the
efforrt investors are willing to expend to gather and trade on information,
hence a non-degenerate market equilibrium will arise only when there are
sufficient profit opportunities, i.e., inefficiencies, to compensate investors for
the costs of trading and information-gathering. The profits earned by these
industrious investors may be viewed as economic rents that accrue to those
willing to engage in such activities."
Lo and MacKinlay (1999), pages 5-6

Efficient Markets Hypothesis and Random


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Home

Holidays
The holiday effect refers to the tendency of the market to do well on any day
which precedes a holiday.

LAKONISHOK, Josef and Seymour SMIDT, 1988. Are seasonal anomalies


real? A ninety-year perspective, The Review of Financial Studies, Vol. 1, No. 4.
(Winter, 1988), pp. 403-425. [Cited by 161] (8.80/year)
Abstract: "This study uses 90 years of daily data on the Dow Jones Industrial
Average to test for the existence of persistent seasonal patterns in the rates of
return. Methodological issues regarding seasonality tests are considered. We find
evidence of persistently anomalous returns around the turn of the week, around
the turn of the month, around the turn of the year, and around holidays."

ARIEL, R.A., 1990. High Stock Returns before Holidays: Existence and
Evidence on Possible Causes, The Journal of Finance, Vol. 45, No. 5. (Dec.,
1990), pp. 1611-1626. [Cited by 64] (3.93/year)
Abstract: "On the trading day prior to holidays, stocks advance with
disproportionate frequency and show high mean returns averaging nine to
fourteen times the mean return for the remaining days of the year. Over one third
of the total return accruing to the market portfolio over the 19631982 period
was earned on the eight trading days which each year fall before holiday market
closings. Examination of hourly pre-holiday stock returns reveals high returns
throughout the day. Pre-holiday stock returns in the post-test 19831986 period
are also examined."

ARSAD, Zainudin and J. Andrew COUTTS. 1997. Security price anomalies in


the London International Stock Exchange: a 60 year perspective,Applied
Financial Economics, Volume 7, Number 5, 1 October 1997, pp. 455-464. [Cited
by 29] (3.12/year)
Abstract: "This paper investigates the existence of security price anomalies, or
calendar effects in the Financial Times Industrial Ordinary Shares Index over a
60 year period: 1 July 1935 through 31 December 1994. Our results broadly
support similar evidence documented for many countries concerning stock
market anomalies, as the weekend, January and holiday effects all appear, to
some extent, to be present in our data set. We conclude, that even if these
anomalies are persistent in their occurrence and magnitude, the cost of
implementing any potential trading rules may be prohibitive due to the
illiquidity of the market and round trip transactions costs. This is of course
perfectly consistent with the notion of market efficiency, in that no strategy
exists that will consistently yield abnormal returns."

MENEU, Vicente and Angel PARDO, 2004. Pre-holiday Effect, Large Trades
and Small Investor Behaviour, Journal of Empirical Finance, Volume 11, Issue
2, March 2004, Pages 231-246. [Cited by 6] (2.61/year)
Abstract: "This paper investigates the existence of a pre-holiday effect in the
most important individual stocks of the Spanish Stock Exchange that are also
traded in both the New York Stock Exchange and the Frankfurt Stock Exchange.
Our results show high abnormal returns on the trading day prior to holidays that
are not related to any calendar anomaly. A thorough study of diverse liquidity-
related measures suggests a new explanation for the pre-holiday effect based on
the reluctance of small investors to buy on pre-holidays. The results of this paper
are important for the practitioners since we show that institutional investors
could have economically exploited this anomaly."

KIM, Chan-Wung and Jinwoo PARK, 1994. Holiday Effects and Stock
Returns: Further Evidence, The Journal of Financial and Quantitative Analysis,
Vol. 29, No. 1. (Mar., 1994), pp. 145-157. [Cited by 30] (2.44/year)
Abstract: "This paper provides further evidence of the holiday effect in stock
returns and additional insight into the effect. This paper reports abnormally high
returns on the trading day before holidays in all three of the major stock markets
in the U.S.: the NYSE, AMEX, and NASDAQ. The holiday effect is also present
in the U.K. and Japanese stock markets, even though each country has different
holidays and institutional arrangements. This study finds that the holiday effects
in the U.K. and Japanese stock markets are independent of the holiday effect in
the U.S. stock market. Unlike the other seasonal patterns in stock returns, such
as January and weekend effects, this investigation of size decile portfolios shows
that the size effect is not present in mean returns on preholidays."

CADSBY, Charles Bram and Mitchell RATNER, 1992. Turn-of-month and pre-
holiday effects on stock returns: Some international evidence, Journal of
Banking & Finance, Volume 16, Issue 3, June 1992, Pages 497-509. [Cited by
34] (2.38/year)

LUCEY, B.M., 2005. Are local or international influences responsible for the
pre-holiday behaviour of Irish equities?. Applied Financial Economics.[Cited by
2] (1.54/year)
LUCEY, B.M. and A. PARDO, 2005. Why investors should not be cautious
about the academic approach to testing for stock market . Applied Financial
Economics 15(3) :165-171 [Cited by 2] (1.54/year)

BROCKMAN, P., 1998. The persistent holiday effect: additional


evidence. Applied Economics Letters. [Cited by 11] (1.33/year)

LIN, J.L. and T.S. LIU, 2002. Modeling Lunar Calendar Holiday Effects in
Taiwan. Taiwan Economic Forecast and Policy. [Cited by 4] (0.93/year)

ECONOMICS, A.F., 2002. The anomalies that aren't there: the weekend,
January and pre-holiday effects on the all gold index . Applied Financial
Economics. [Cited by 4] (0.93/year)

REDMAN, Arnold L., Herman MANAKYAN and Kartono LIANO, 1997. Real
Estate Investment Trusts and Calendar Anomalies. Journal of Real Estate
Research. [Cited by 8] (0.86/year)

VERGIN, Roger C. and John McGINNIS 1999. Revisiting the Holiday Effect:
is it on holiday?. Applied Financial Economics. [Cited by 6] (0.82/year)

ZIEMBA, W.T., 1990. Japanese Security Market Regularities: Monthly, Turn of


the Month and Year, Holiday and Golden Week . ideas.repec.org. [Cited by
11] (0.68/year)

LIANO, K., P.H. MARCHAND and G.C. HUANG, 1992. The holiday effect in
stock returns: Evidence from the OTC market. Review of Financial
Economics. [Cited by 9] (0.63/year)

TAKEI, A., et al., 2003. 'Drug holiday' effects of tandospirone in a patient with
Machado-Joseph disease. Psychiatry and Clinical Neurosciences.[Cited by 2]
(0.61/year)

HELLSTR?M, Thomas and Kenneth HOLMSTR?M, 1998. Predictable


patterns in stock returns. mdh.se. [Cited by 5] (0.60/year)

PEARCE, Douglas K., 1996. The Robustness of Calendar Anomalies in Daily


Stock Returns. Journal of Economics and Finance. [Cited by 6] (0.58/year)

BROCKMAN, P., 1995. A review and analysis of the holiday effect. Financial
Markets, Institutions & Instruments. [Cited by 5] (0.44/year)
MERRILL, A.A., 1966. Behavior of Prices on Wall Street. Analysis Press.
[Cited by 8] (0.20/year)

CHENG, S.W., 1996. The Impact of Holidays on the Trading Pattern of


Australian Share Price Index Futures. Honours Dissertation, Department of
Accounting and Finance, . [Cited by 2] (0.19/year)

FIELDS, M.J., 1934. Security prices and stock exchange holidays in relation to
short selling, The Journal of Business of the University of Chicago, Vol. 7, No.
4. (Oct., 1934), pp. 328-338. [Cited by 12] (0.17/year)

LIANO, K. and L.R. WHITE, 1994. Business Cycles and the Pre-holiday
Effect in Stock Returns. Applied Financial Economics. [Cited by 2] (0.16/year)

KAM, S.W., 1995. of Daily Foreign Exchange Rates with Non-normal


Assumption and Day-of-the-week and Holiday Effects. Dept. of Economics,
University of Queensland. [Cited by 1] (0.09/year)

HIRAKI, Takato and Edwin D. MABERLY, An Analysis of Japanese Stock


Return Dynamics Conditional on US Monday Holiday
Closures.papers.ssrn.com. [not cited] (0/year)

Weekend Effect

The weekend effect (also known as the Monday effect, the day-of-the-
week effect or the Monday seasonal) refers to the tendency of stocks to exhibit
relatively large returns on Fridays compared to those on Mondays. This is a
particularly puzzling anomaly because, as Monday returns span three days, if
anything, one would expect returns on a Monday to be higher than returns for
other days of the week due to the longer period and the greater risk.

Articles via Google Scholar

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Articles published since

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Seminal

French (1980)

Important
HAWAWINI, G. and D.B. KEIM, 1995. On the predictability of common stock
returns: World-wide evidence. In: Handbooks in Operations Research and
Management Science, Volume 9, Finance, pages 497-544. [Cited by 58] (4.06/year)
Abstract: "Recent empirical findings suggest that equity returns are predictable.
These findings document persistent cross- sectional and time series patterns in
returns that are not predicted by extant theory, and are, therefore, often classified
as anomalies. In this paper we synthesize the evidence on predictable returns,
focusing on the subset of the findings whose existence has proved most robust with
respect to both time and the number of stock markets in which they have been
observed."

SCHWERT, G. William, 2002. Anomalies and Market Efficiency, Handbook of the


Economics of Finance, pages 937-972. [Cited by 78] (18.18/year)

FRENCH, Kenneth R., 1980. Stock Returns and the Weekend Effect, Journal of
Financial Economics, Volume 8, Issue 1, March 1980, Pages 55-69. [Cited by 310]
(11.79/year)
Abstract: "This paper examines two alternative models of the process generating
stock returns. Under the calendar time hypothesis, the process operates
continuously and the expected return for Monday is three times the expected return
for other days of the week. Under the trading time hypothesis, returns are
generated only during active trading and the expected return is the same for each
day of the week. During most of the period studied, from 1953 through 1977, the
daily returns to the Standard and Poor's composite portfolio are inconsistent with
both models. Although the average return for the other four days of the week was
positive, the average for Monday was significantly negative during each of five-year
subperiods."

RUBINSTEIN, M., 2001. Rational Markets: Yes or No? The Affirmative


Case, Financial Analysts Journal, volume 57, number 3 (May/June), pages 15-29.
[Cited by 71] (11.29/year)
Abstract: "With the recent flurry of articles declaiming the death of the rational
market hypothesis, it is well to pause and recall the very sound reasons this
hypothesis was once so widely accepted, at least in academic circles. Although
academic models often assume that all investors are rational, this assumption is
clearly an expository device not to be taken seriously. What is in contention is
whether markets are rational in the sense that prices are set as if all investors are
rational. Even if markets are not rational in this sense, abnormal profit opportunities
still may not exist. In that case, markets may be said to be minimally rational. I
maintain that not only are developed financial markets minimally rational, they are,
with two qualifications, rational. I contend that, realistically, market rationality
needs to be defined so as to allow investors to be uncertain about the
characteristics of other investors in the market. I also argue that investor
irrationality, to the extent that it affects prices, is particularly likely to be manifest
through overconfidence, which in turn, is likely to make the market hyper-rational.
To illustrate, the article reexamines some of the most serious historical evidence
against market rationality."

HARRIS, Lawrence, 1986. A transaction data study of weekly and intradaily


patterns in stock returns, Journal of Financial Economics, Volume 16, Issue 1 , May
1986, Pages 99-117. [Cited by 184] (9.07/year)
Abstract: "Weekly and intradaily patterns in common stock prices are examined
using transaction data. For large firms, negative Monday close-to-close returns
accrue between the Friday close and the Monday open; for smaller firms they
accrue primarily during the Monday trading day. For all firms, significant weekday
differences in intraday returns accrue during the first 45 minutes after the market
opens. On Monday mornings, prices drop, while on the other weekday mornings,
they rise. Otherwise the pattern of intraday returns is similar on all weekdays. Most
notable is an increase in prices on the last trade of the day."

LAKONISHOK, Josef and Seymour SMIDT, 1988. Are seasonal anomalies real? A
ninety-year perspective, The Review of Financial Studies, Vol. 1, No. 4. (Winter,
1988), pp. 403-425. [Cited by 161] (8.80/year)
Abstract: "This study uses 90 years of daily data on the Dow Jones Industrial
Average to test for the existence of persistent seasonal patterns in the rates of
return. Methodological issues regarding seasonality tests are considered. We find
evidence of persistently anomalous returns around the turn of the week, around the
turn of the month, around the turn of the year, and around holidays."

GIBBONS, Michael R. and Patrick HESS, 1981. Day of the Week Effects and Asset
Returns, The Journal of Business, Vol. 54, No. 4. (Oct., 1981), pp. 579-596. [Cited by
176] (6.96/year)
Abstract: "A traditional distributional assumption regarding the returns on a financial
asset specifies that the expected returns are identical for all days of the week.
Contrary to this plausible assumption, this paper discovers that the expected
returns on common stocks and treasury bills are not constant across days of the
week. The most notable evidence is for Monday's returns where the mean is
unusually low or even negative. Several explanations of the results are investigated,
but none proves satisfactory. Aside from documenting significant day of the week
effects, the implications of the results for tests of market efficiency are examined.
While market-adjusted returns continue to exhibit day of the week effects, these
effects are no longer concentrated on Monday."

KEIM, Donald B. and Robert F. STAMBAUGH, 1984. A Further Investigation of the


Weekend Effect in Stock Returns, The Journal of Finance, Vol. 39, No. 3, Papers and
Proceedings, Forty-Second Annual Meeting, American Finance Association, San
Francisco, CA, December 28-30, 1983. (Jul., 1984), pp. 819-835. [Cited by 146]
(6.55/year)
Abstract: "This study uses a longer time period and additional stocks to further
investigate the weekend effect. We find consistently negative Monday returns (1) for
the S & P Composite as early as 1928, (2) for Exchange-traded stocks of firms of all
sizes, and (3) for actively traded over-the-counter (OTC) stocks. The OTC results are
based on bid prices and therefore appear to reject specialist-related explanations.
For the 30 individual stocks of the Dow Jones Industrial Index, the average
correlation between Friday and Monday returns is positive and the highest of all
pairs of successive days. The latter finding is inconsistent with fairly general
measurement-error explanations."

AGRAWAL, Anup and Kishore TANDON, 1994. Anomalies or illusions? Evidence


from stock markets in eighteen countries, Journal of International Money and
Finance, Volume 13, Issue 1, February 1994, Pages 83-106. [Cited by 75] (6.10/year)
Abstract: "This paper examines five seasonal patterns in stock markets of eighteen
countries: the weekend, turn-of-the-month, end-of-December, monthly and Friday-
the-thirteenth effects. We find a daily seasonal in nearly all the countries, but a
weekend effect in only nine countries. Interestingly, the daily seasonal largely
disappears in the 1980s. The last trading day of the month has large returns and
low variance in most countries. Many countries have large December pre-holiday
and inter-holiday returns. The January returns are large in most countries and a
significant monthly seasonal exists in ten countries."

ABRAHAM, Abraham and David L. IKENBERRY, 1994. The Individual Investor and
the Weekend Effect, The Journal of Financial and Quantitative Analysis, Vol. 29, No.
2. (Jun., 1994), pp. 263-277. [Cited by 71] (5.78/year)
Abstract: "It is well known that stock returns, on average, are negative on Mondays.
Yet, it is less well known that this finding is substantially the consequence of returns
in prior trading sessions. When Friday's return is negative, Monday's return is
negative nearly 80 percent of the time with a mean return of -0.61 percent. When
Friday's return is positive, the subsequent Monday's mean return is positive, 0.11
percent. This relationship is stronger than for any other pair of trading days and is
most acute in small- and medium-size companies. The trading behavior of individual
investors appears to be at least one factor contributing to this pattern. Individual
investors are more active sellers of stock on Mondays, particularly following bad
news in the market."

LAKONISHOK, Josef and Edwin MABERLY, 1990. The Weekend Effect: Trading
Patterns of Individual and Institutional Investors, The Journal of Finance, Vol. 45, No.
1. (Mar., 1990), pp. 231-243. [Cited by 94] (5.77/year)
Abstract: "In this paper, we document regularities in trading patterns of individual
and institutional investors related to the day of the week. We find a relative increase
in trading activity by individuals on Mondays. In addition, there is a tendency for
individuals to increase the number of sell transactions relative to buy transactions,
which might explain at least part of the weekend effect."

CONNOLLY, Robert A., 1989. An Examination of the Robustness of the Weekend


Effect, The Journal of Financial and Quantitative Analysis, Vol. 24, No. 2. (Jun., 1989),
pp. 133-169. [Cited by 98] (5.67/year)
Abstract: "This paper analyzes the robustness of the day-of-the-week (DOW) and
weekend effects to alternative estimation and testing procedures. The results show
that sample size can distort the interpretation of classical test statistics unless the
significance level is adjusted downward. Specification tests reveal widespread
departures from OLS assumptions. Hypothesis tests results are reported using
robust econometric methods and a GARCH model. The strength of the DOW and
weekend effect evidence appears to depend on the estimation and testing method.
Both effects seem to have disappeared by 1975."

STEELEY, James M., 2001. A note on information seasonality and the


disappearance of the weekend effect in the UK stock market, Journal of Banking and
Finance, Volume 25, Issue 10, October 2001, Pages 1941-1956. [Cited by 27]
(5.11/year)
Abstract: "The weekend effect in UK stock prices has disappeared in the 1990s.
Beneath the surface however there remain systematic day-of-the-week effects only
visible when returns are partitioned by the direction of the market. A systematic
pattern of market-wide news arrivals into the UK stock market is discovered and
found to provide an explanation for these day-of-the-week effects."

SULLIVAN, Ryan, Allan TIMMERMANN and Halbert WHITE, 2001. Dangers of data
mining: the case of calendar effects in stock returns, Journal of Econometrics,
Volume 105, Issue 1, November 2001, Pages 249-286. [Cited by 41] (4.95/year)
Abstract: "Economics is primarily a non-experimental science. Typically, we cannot
generate new data sets on which to test hypotheses independently of the data that
may have led to a particular theory. The common practice of using the same data
set to formulate and test hypotheses introduces data-mining biases that, if not
accounted for, invalidate the assumptions underlying classical statistical inference.
A striking example of a data-driven discovery is the presence of calendar effects in
stock returns. There appears to be very substantial evidence of systematic
abnormal stock returns related to the day of the week, the week of the month, the
month of the year, the turn of the month, holidays, and so forth. However, this
evidence has largely been considered without accounting for the intensive search
preceding it. In this paper we use 100 years of daily data and a new bootstrap
procedure that allows us to explicitly measure the distortions in statistical inference
induced by data mining. We find that although nominal p-values for individual
calendar rules are extremely significant, once evaluated in the context of the full
universe from which such rules were drawn, calendar effects no longer remain
significant."

JAFFE, Jeffrey and Randolph WESTERFIELD, 1985. The Week-End Effect in


Common Stock Returns: The International Evidence, The Journal of Finance, Vol. 40,
No. 2. (Jun., 1985), pp. 433-454. [Cited by 100] (4.70/year)
Abstract: "This paper examines the daily stock market returns for four foreign
countries. We find a so-called week-end effect in each country. In addition, the
lowest mean returns for the Japanese and Australian stock markets occur on
Tuesday. The remainder of the paper answers four questions. Are seasonal patterns
in foreign stock markets independent of those previously reported in the U.S.? Do
Japan and Australia exhibit a seasonal one day out of phase due to different time
zones? Do settlement procedures across countries bias week-end effects? Does the
seasonal pattern in foreign exchange offset the week-end effect in stocks for
Americans investing overseas?"

WANG, Ko, Yuming LI and John ERICKSON, 1997. A New Look at the Monday
Effect, The Journal of Finance, Vol. 52, No. 5. (Dec., 1997), pp. 2171-2186. [Cited by
43] (4.63/year)
Abstract: "It is well documented that expected stock returns vary with the day-of-
the-week (the Monday or weekend effect). In this article we show that the well-
known Monday effect occurs primarily in the last two weeks (fourth and fifth weeks)
of the month. In addition, the mean Monday return of the first three weeks of the
month is not significantly different from zero. This result holds for most of the
subperiods during the 1962-1993 sampling period and for various stock return
indexes. The monthly effect reported by Ariel (1987) and Lakonishok and Smidt
(1988) cannot fully explain this phenomenon."

KAMARA, Avraham, 1997. New Evidence on the Monday Seasonal in Stock


Returns, The Journal of Business, Vol. 70, No. 1. (Jan., 1997), pp. 63-84. [Cited by 41]
(4.41/year)
Abstract: "Equity derivatives and the institutionalization of equity markets affect the
Monday seasonal. The seasonal in the Standard and Poor's 500 (S&P) declines
significantly over 1962-93. This decline is positively related to the ratio of
institutional to individual trading volume. In contrast, the seasonal for small stocks
does not decline and is unaffected by institutional versus individual trading. Higher
trading costs sustain the seasonal in small stock, and unlike the S&P, theses costs
are not lower for institutions than for individuals. Futures minus spot S&P returns
exhibit a reverse seasonal. Informed traders use the less costly market to exploit
the seasonal."

CHEN, Honghui and Vijay SINGAL, 2003. Role of Speculative Short Sales in Price
Formation: The Case of the Weekend Effect, The Journal of Finance, Volume 58,
Number 2, April 2003, pp. 685-706. [Cited by 14] (4.26/year)
Abstract: "We argue that short sellers affect prices in a significant and systematic
manner. In particular, we contend that speculative short sales contribute to the
weekend effect: The inability to trade over the weekend is likely to cause these
short sellers to close their speculative positions on Fridays and reestablish new
short positions on Mondays causing stock prices to rise on Fridays and fall on
Mondays. We find evidence in support of this hypothesis based on a comparison of
high short-interest stocks and low short-interest stocks, stocks with and without
actively traded options, IPOs, zero short-interest stocks, and highly volatile stocks."

CHAN, Su Han, Wai-Kin LEUNG and Ko WANG, 2004. The Impact of Institutional
Investors on the Monday Seasonal, The Journal of Business, Volume 77, Number 4
(October 2004), pages 967-986. [Cited by 9] (3.93/year)
Abstract: "It is well documented that the mean Monday return is significantly
negative and is lower than the mean return on other weekdays. Using institutional
stock holdings information during the 19811998 period, we document that the
Monday seasonal is stronger in stocks with low institutional holdings and that the
Monday return is not significantly different from the mean Tuesday to Friday returns
for stocks with high institutional holdings during the 19901998 period. Our study
provides direct evidence to support the belief that the Monday seasonal may be
related to the trading activities of less sophisticated individual investors."

LAKONISHOK, Josef and Maurice LEVI, 1982. Weekend Effects on Stock Returns: A
Note, The Journal of Finance, Vol. 37, No. 3. (Jun., 1982), pp. 883-889. [Cited by 92]
(3.79/year)
"SOME RESEARCHERS HAVE APPARENTLY been surprised to discover that the
distribution of stock returns depends on the day of the week. 1 Kenneth French [3],
for example, in testing whether daily stock returns are generated by a trading time
or calendar time hypothesis, provided convincing evidence of a negative market
return on Mondays. As French carefully notes, this finding runs counter to both
hypotheses, since a trading time view would have expected stock returns equal on
different days, and a calendar time view would have higher expected returns on
Monday to compensate for the longer holding period.
In this paper we offer a partial explanation for the apparently puzzling discovery of
different daily returns. We argue that the expected stock returns as measured, for
example, from closing prices, should depend on the day of the week. In general, we
argue that the expected returns on Mondays should be lower than would be implied
simply by a trading time or calendar time model, and the returns on Fridays should
be higher. In addition, we anticipate that holidays will have complex effects on stock
returns on other days of the week. Our argument is based on the delay between
trading and settlements in stocks and in clearing checks. The explanation that we
offer for different measured daily returns does not contradict the efficient market
hypothesis, as correctly adjusted expected returns should not differ according to the
day of the week."

ROGALSKI, Richard J., 1984. New Findings Regarding Day-of-the-Week Returns


over Trading and Non-Trading Periods: A Note, The Journal of Finance, Vol. 39, No. 5.
(Dec., 1984), pp. 1603-1614. [Cited by 82] (3.68/year)
Abstract: "This paper decomposes daily close to close returns into trading day and
non-trading day returns. We discover that all of the average negative returns from
Friday close to Monday close documented in the literature for stock market indexes
occurs during the non-trading period from Friday close to Monday open. In addition,
average trading day returns (open to close) are identical for all days of the week.
January/firm size/turn-of-the-year anomalies are shown to be interrelated with day-
of-the-week returns."

DUBOIS, M. and P. LOUVET, 1996. The day-of-the-week effect: the international


evidence, Journal of Banking and Finance, Volume 20, Issue 9, November 1996,
Pages 1463-1484. [Cited by 35] (3.40/year)
Abstract: "We re-examine the day-of-the-week effect for eleven indexes from nine
countries during the 19691992 period. The standard methodology as well as the
moving average methodology are used and we find returns to be lower at the
beginning of the week (but not necessarily on Monday) for the full period. As in
Chang et al. (International evidence on the robustness of the day-of-the-week effect,
Journal of Financial and Quantitative Analysis 28 (1993), 497514), the anomaly
disappears for the most recent period in the USA. However, the effect is still strong
for European countries, Hong-Kong and Toronto."

\citeasnoun{}
AGGARWAL, Reena and Pietra RIVOLI, 1989. Seasonal and Day-of-the-Week
Effects in Four Emerging Stock Markets, The Financial Review, Vol. 24, Issue 4
(November 1989), Pages 541-550. [Cited by 54] (3.12/year)
The January effect and the weekend effect have proven to be persistent
anomalies in U.S. equity markets. The objective of this paper is to examine seasonal
and daily patterns in equity returns of four emerging markets: Hong Kong,
Singapore, Malaysia, and the Philippines. These markets are gaining importance
with the globalization of business; therefore, it is necessary to examine the
efficiency and functioning of these capital markets. Our analysis uses daily data for
the 12 years from September 1, 1976, to June 30, 1988. The results support the
existence of a seasonal pattern in these markets. Returns in the month of January
are higher than any other month for all markets examined except the Philippines. A
robust day-of-the-week effect is also found. These markets exhibit a weekend effect
of their own in the form of low Monday returns. In addition, there exists a strong
Tuesday effect, which may be related to the + 13 hour time difference between
New York and these emerging markets."

ARSAD, Zainudin and J. Andrew COUTTS. 1997. Security price anomalies in the
London International Stock Exchange: a 60 year perspective, Applied Financial
Economics, Volume 7, Number 5, 1 October 1997, pp. 455-464. [Cited by 29]
(3.12/year)
Abstract: "This paper investigates the existence of security price anomalies, or
calendar effects in the Financial Times Industrial Ordinary Shares Index over a 60
year period: 1 July 1935 through 31 December 1994. Our results broadly support
similar evidence documented for many countries concerning stock market
anomalies, as the weekend, January and holiday effects all appear, to some extent,
to be present in our data set. We conclude, that even if these anomalies are
persistent in their occurrence and magnitude, the cost of implementing any
potential trading rules may be prohibitive due to the illiquidity of the market and
round trip transactions costs. This is of course perfectly consistent with the notion
of market efficiency, in that no strategy exists that will consistently yield abnormal
returns."

SIAS, Richard W. and Laura T. STARKS, 1995. The Day-of-the-Week Anomaly: The
Role of Institutional Investors, Financial Analysts Journal, May/June 1995, Vol. 51, No.
3: pp. 58-67. [Cited by 33] (2.92/year)

CHOUDHRY, T., 2000. Day of the week effect in emerging Asian stock markets:
evidence from the GARCH model, Applied Financial Economics, Volume 10, Number
3, 1 June 2000, pp. 235-242. [Cited by 18] (2.86/year)
Abstract: "This paper investigates the day of the week effect on seven emerging
Asian stock markets returns and conditional variance (volatility). The empirical
research was conducted using the GARCH model and daily returns from India,
Indonesia, Malaysia, Philippines, South Korea, Taiwan, and Thailand from January
1990 to June 1995. Results obtained indicate the significant presence of the day of
the week effect on both stock returns and volatility, though the result involving both
the return and volatility are not identical in all seven cases. Results also show that
these effects may be due to a possible spill-over from the Japanese stock market."

\citeasnoun{}
CHEN, G., 2001. The day-of-the-week regularity in the stock markets of
China. Journal of Multinational Financial Management. [Cited by 15] (2.84/year)

CHANG, Eric C., J. Michael PINEGAR and R. RAVICHANDRAN, 1993. International


Evidence on the Robustness of the Day-of-the-Week Effect, The Journal of Financial
and Quantitative Analysis, Vol. 28, No. 4. (Dec., 1993), pp. 497-513. [Cited by 37]
(2.78/year)
Abstract: "Consistent with Connolly's (1989), (1991) evidence, this study finds that
sample size and/or error term adjustments render U.S. day-of-the-week effects
statistically insignificant. In contrast, day-of-the-week effects in seven European
countries and in Canada and Hong Kong are robust to individual sample size or error
term adjustments, and day-of-the-week effects in five European countries survive
the simultaneous imposition of both types of adjustments. In most countries where
day-of-the-week effects are robust, however, the effects are statistically significant
in not more than two weeks out of the month. These findings are inconsistent with
explanations of the day-of-the-week effect based on institutional differences or on
the arrival of new information. Thus, in the absence of other potential explanations
already dismissed by Jaffe and Westerfield (1985), evidence in this study further
complicates the international day-of-the-week effect puzzle."

\citeasnoun{}
CROSS, Frank, 1973. The Behavior of Stock Prices on Fridays and
Mondays, Financial Analysts Journal, November/December 1973, Vol. 29, No. 6: 67-
69. [Cited by 91] (2.73/year)

MEHDIAN, Seyed and Mark J. PERRY, 2001. The Reversal of the Monday Effect:
New Evidence from US Equity Markets, Journal of Business Finance & Accounting,
Volume 28, Numbers 7-8, September/October 2001, pp. 1043-1065. [Cited by 14]
(2.65/year)
Abstract: "This article re-examines the Monday effect in the US stock market from
1964-1999 using daily returns from three large-cap indexes and two small-cap
indexes. In the period before 1987, Monday returns are significantly negative in all
five US stock indexes, confirming previous empirical findings. In the post-1987
period, we uncover a significant reversal of the Monday effect in the large-cap
indexes (NYSE, S&P500 and DJCOMP), since Monday returns are significantly
positive. Furthermore, significant differences in the persistence and reversal of the
Monday effect are found between large-cap and small-cap stock indexes."
\citeasnoun{}
BALABAN, Ercan, 1995. Day of the week effects: new evidence from an emerging
stock market, Applied Economics Letters, Volume 2, Number 5, 1 May 1995, pp.
139-143. [Cited by 29] (2.57/year)
Abstract: "The primary objective is to investigate day of the week effects in an
emerging stock market of a developing country, namely Turkey. Empirical results
verify that although day of the week effects are present in Istanbul Securities
Exchange Composite Index (ISECI) return data for the period January 1988 to August
1994, these effects change in direction and magnitude through time."

DAMODARAN, A., 1989. The weekend effect in information releases: a study of


earnings and dividend announcements, Review of Financial Studies, Volume 2,
Number 4, Pp. 607-623. [Cited by 36] (2.08/year)

MILLER, E., 1988. Why a Weekend Effect? Journal of Portfolio


Management. [Cited by 36] (1.97/year)Journal of Portfolio Management 14,
43-48, (Summer 1988).
ALEXAKIS, P. and M. XANTHAKIS, 1995. Day of the week effect on the Greek
stock market. Applied Financial Economics. [Cited by 22] (1.95/year)Applied
Financial Economics Volume (Year): 5 (1995) Issue (Month): 1
(February) Pages: 43-50
PENMAN, S.H., 1987. The distribution of earnings news over time and
seasonalities in aggregate stock returns. Journal of Financial Economics 18:199-228.
[Cited by 37] (1.92/year)
BERUMENT, H. and H. KIYMAZ, 2001. The Day of the Week Effect on Stock Market
Volatility. Journal of Economics and Finance. [Cited by 10] (1.89/year)
KIYMAZ, H. and H. BERUMENT, 2003. The day of the week effect on stock market
volatility and volume: International evidence. Review of Financial Economics. [Cited
by 6] (1.83/year)
BRUSA, J., P. LIU and C. SCHULMAN, 2000. The Weekend Effect,'Reverse'
Weekend Effect, and Firm Size. Journal of Business Finance & Accounting. [Cited by
11] (1.75/year)
JAFFE, J., R. WESTERFIELD and C. MA, 1989. A twist on the Monday effect in stock
prices: evidence from the US and foreign stock markets. Journal of Banking and
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BHATTACHARYA, K., N. SARKAR and D. MUKHOPADHYAY, 2003. Stability of the
day of the week effect in return and in volatility at the Indian capital market: a
. Applied Financial Economics. [Cited by 5] (1.52/year)
LUCEY, B.M., 2000. Anomalous daily seasonality in Ireland?. Applied Economics
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PETTENGILL, Glenn N., 2003. A Survey of the Monday Effect Literature, Quarterly
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(1.22/year)\citeasnoun{}

CLARE, A.D., M.S.B. IBRAHIM and S.H. THOMAS, 1998. The Impact of Settlement
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(1.21/year)
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Effect Using Intraday Data. Journal of Business Finance and Accounting.[Cited by 11]
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Cointegration
Cointegration (Engle and Granger, 1987) is an econometric technique for
testing the relationship between non-stationary time series variables. If two or
more series each have a unit root, that is I(1), but a linear combination of them
is stationary, I(0), then the series are said to be cointegrated.
For example, a stock market index and the price of its associated futures
contract, whilst both following a random walk, will be in a long-run
equilibrium and deviations from this equilibrium will be stationary.
Robert Engle and Clive Granger shared the 2003 Bank of Sweden Prize in
Economic Sciences in Memory of Alfred Nobel, the latter's portion due to his
contribution to the development of cointegration.
Sewell (2006)

Books
Amazon.com: Books Search Results: cointegration

"Market Models: A Guide to Financial Data Analsis" by Carol Alexander, 2001,


John Wiley & Sons, Ltd
"Pairs Trading: Quantitative Methods and Analysis" by Ganapathy
Vidyamurthy, 2004, John Wiley & Sons, Inc.

Top Ten Publications


1. ENGLE, R.F. and C.W.J. GRANGER, 1987. Cointegration and error
correction: representation, estimation and testing. [Cited by 3830] (206.51/year)

2. PEDRONI, P., 2004. PANEL COINTEGRATION: ASYMPTOTIC AND


FINITE SAMPLE PROPERTIES OF POOLED TIME SERIES TESTS WITH
AN . Econometric Theory. [Cited by 165] (106.71/year)

3. JOHANSEN, S. and K. JUSELIUS, 1990. Maximum likelihood estimation and


infere nce on cointegration--with applications to the demand for . [Cited by
1628] (104.72/year)

4. JOHANSEN, S. and K. JUSILIUS, 1991. Estimation and Hypothesis Testing of


Cointegration Vectors in Gaussian Vector Autoregressive Models. [Cited by
1392] (95.69/year)

5. HYLLEBERG, S., et al., 2001. Seasonal integration and


cointegration. Causality, Integration And Cointegration, And Long
Memory. [Cited by 367] (80.73/year)

6. MACKINNON, J.G., R.F. ENGLE and C.W.J. GRANGER, 1991. Critical


values for cointegration tests. Long-Run Economic Relationships: Readings in
Cointegration. [Cited by 960] (66.00/year)

7. MADDALA, G.S. and I.M. KIM, 1999. Unit Roots, Cointegration, and
Structural Change. books.google.com. [Cited by 411] (62.78/year)

8. BANERJEE, A., et al., 1993. Co-Integration, Error-Correction, and the


Econometric Analysis of Non-Stationary Data. ingentaconnect.com. [Cited by
591] (47.11/year)

9. OSTERWALD-LENUM, M., 1992. of the asymptotic dis trib ution of the


maximum likelihood cointegration rank test statistics.. [Cited by 620]
(45.77/year)

10. GONZALO, J. and C.W.J. GRANGER, 2001. Estimation of Common Long-


Memory Components in Cointegrated Systems. Harvard University Press
Cambridge, MA, USA. [Cited by 195] (42.89/year)
Links
About.com: Cointegration

gummy stuff: cointegration

Wikipedia: Cointegration

Bibliography
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BANERJEE, A., et al., 1993. Co-Integration, Error-Correction, and the


Econometric Analysis of Non-Stationary Data. ingentaconnect.com. [Cited by
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BANERJEE, A., J. DOLADO and R. MESTRE, 1998. Error-correction


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ENGLE, R.F. and C.W.J. GRANGER, 1987. Cointegration and error


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ENGLE, R.F., et al., 1991. Long-run economic relationships: readings in


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ENGLE, R.F., et al., 1993. Seasonal cointegration: the Japanese consumption
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FISHER, E.O.N. and J.Y. PARK, 1991. Testing Purchasing Power Parity under
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FRANSES, P.H. and N. HALDRUP, 1993. The effects of additive outliers on


tests for unit roots and cointegration. [Cited by 71] (5.66/year)

GERDTHAM, U.G. and M. LTHGREN, 2000. On stationarity and


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GONZALO, J. and C.W.J. GRANGER, 2001. Estimation of Common Long-


Memory Components in Cointegrated Systems. Harvard University Press
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GREGORY, A. and B.E. HANSEN, 1992. Residual-based tests for


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