Abstract
This paper tests the stock market rationality hypothesis, which implies that a stock price is determined as the discounted sum of optimally forecasted future dividends. Mankiw-Romer-Shapiro volatility tests and new volatility tests which do not use the unobservable “ex post rational price” are applied to the data from a stock market in Japan. A Hausman type specification test of the market rationality hypothesis is also developed and applied to the data. The results suggest that we cannot reject the hypothesis that the Japanese stock market is rational. A couple of variance inequalities are violated by the data but the violation does not seem to be significant. J. Japan. Int. Econ., December 1987, 1(4), pp. 441–462. Massachusetts Institute of Technology, Cambridge, MA 02139.
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