1 - Market efficiency and forecasting

Abstract

This chapter focuses on developments following Fama's review related to prediction of stock prices. In the review Fama describes increasingly fine information that is useful in organizing the discussion. It is mentioned that weak-form predictability uses the information in past stock prices. Semi-strong form predictability uses variables that are publicly available, and strong form uses anything else. The weak-form predictability (using the information in past stock prices) is more fragile and less compelling than the semi-strong form predictability (using publicly available information more generally). Further, the review highlights the issue of predictability in stock returns, which has important and broad economic implications relating to the efficiency of capital markets in allocating resources to their highest valued uses. The discussion concludes with conditional asset pricing models, which provided a rich setting for the study of the dynamic behavior of asset markets. Conditional Performance Evaluation is the application of these models to the problem of evaluating the performance of portfolio managers. Models that allow for time-varying conditional moments produce different inferences about performance thanthe traditional measures that do not allow for predictability, and have influenced both academic views and professional investment practice. It mentions that research on predictability has stimulated numerous advances in the statistical and econometric methods of financial economics and is likely to continue.