TY - JOUR

T1 - Using a Stochastic Complexity Measure to Check the Efficient Market Hypothesis

AU - Shmilovici, Armin

AU - Alon-Brimer, Yael

AU - Hauser, Shmuel

PY - 2003/12

Y1 - 2003/12

N2 - The weak form of the Efficient Market Hypothesis (EMH) states that current market price reflects fully the information from past prices and rules out prediction based on price data alone. No recent test of time series of stock returns rejects this weak-form hypothesis. This research offers another test of the weak form of the EHM that leads to different conclusions for some time series.The stochastic complexity of a time series is a measure of the number of bits needed to represent and reproduce the information in the time series. In an efficient market, compression of the time series is not possible, because there are no patterns and the stochastic complexity is high. In this research, Rissanen's context tree algorithm is used to identify recurring patterns in the data, and use them for compression. The weak form of the EMH is tested for 13 international stock indices and for all the stocks that comprise the Tel-Aviv 25 index (TA25), using sliding windows of 50, 75, and 100 consecutive daily returns. Statistically significant compression is detected in ten of the international stock index series. In the aggregate, 60% to 84% of the TA25 stocks tested demonstrate compressibility beyond randomness. This indicates potential market inefficiency.

AB - The weak form of the Efficient Market Hypothesis (EMH) states that current market price reflects fully the information from past prices and rules out prediction based on price data alone. No recent test of time series of stock returns rejects this weak-form hypothesis. This research offers another test of the weak form of the EHM that leads to different conclusions for some time series.The stochastic complexity of a time series is a measure of the number of bits needed to represent and reproduce the information in the time series. In an efficient market, compression of the time series is not possible, because there are no patterns and the stochastic complexity is high. In this research, Rissanen's context tree algorithm is used to identify recurring patterns in the data, and use them for compression. The weak form of the EMH is tested for 13 international stock indices and for all the stocks that comprise the Tel-Aviv 25 index (TA25), using sliding windows of 50, 75, and 100 consecutive daily returns. Statistically significant compression is detected in ten of the international stock index series. In the aggregate, 60% to 84% of the TA25 stocks tested demonstrate compressibility beyond randomness. This indicates potential market inefficiency.

KW - context tree

KW - stochastic complexity

KW - the Efficient Market Hypothesis

UR - http://www.scopus.com/inward/record.url?scp=84867924938&partnerID=8YFLogxK

U2 - 10.1023/A:1026198216929

DO - 10.1023/A:1026198216929

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AN - SCOPUS:84867924938

SN - 0927-7099

VL - 22

SP - 273

EP - 284

JO - Computational Economics

JF - Computational Economics

IS - 2-3

ER -