A Semi‐Strong Form Evaluation of the Efficiency of the Hog Futures Market: Comment

Abstract

greater forecasting merit than did the respective futures prices, the authors concluded that the hog futures market is semi-strong inefficient. As LH observe, an efficient market has been defined by Fama as one in which prices fully reflect all available information. For any test of the efficient markets hypothesis (EMH) to be operational, one must identify relevant explanatory variables and the specific nature of the linking relation. Thus, any test of the EMH is, at the same time, a test of the postulated model. LH model has little, if any, basis in theory; therefore, the model itself would be a prime suspect in any test of market efficiency. LH state, The hog futures prices cannot consistently be relied upon to reflect accurately subsequent spot prices, and thereby the market is not considered efficient. LH have destroyed a straw man; the EMH does not say, imply, or hint that futures prices in an efficient market can be relied upon to reflect subsequent cash prices accurately. Instead, the EMH does state that known information is impounded in current price, so that all desirable characteristics of the investment (usually expected return) are in equilibrium with all undesirable characteristics of the investment (usually covariance of return with that of the market portfolio). Unless returns resulting from the use of a pricing model like that of LH are found to be in excess of returns justified by risk, the EMH cannot reasonably be rejected. Thus, for an appropriate test of market efficiency, it would be necessary to determine whether returns received from trading based on the econometric model exceed normal returns adjusted for risk. As Rendleman and Carabini (p. 913) state, To determine the extent of the (Treasury Bill Futures) market, it is necessary to assess the significance of the quasi-arbitrage returns that could have been earned. If risk cannot be