Weak Form Market Efficiency - Definition
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Weak Form Market Efficiency Definition
Weak form market efficiency, also known as he random walk theory is part of the efficient market hypothesis. The efficient market hypothesis concerns the extent to which outside information has an effect upon the market price of a security. There are three beliefs or views: Strong, Semi-strong, and Weak. The weak form efficiency view is that past movements in the price of the security and the data on the volume of trades do not affect the securities value. All current information available is already reflected in the price of the security. All past information is irrelevant. As such, investors should study company forward-looking information to determine when stocks are over-priced and under-priced. It is, pursuant to this theory, very difficult to outperform the market (particularly in the short run).
A Little More on What is Weak Form Market Efficiency
The concept of weak form market efficiency was proposed by Professor Burton G. Milkier in his book, A Random Walk Down Wall Street. It labeled technical analysis of securities (based upon past information) as largely inaccurate and pointed out the many flaws in fundamental stock analysis. Because the theory states that past information on price and volume trading of a security is irrelevant, it cannot be used to make decisions on future pricing. More specifically, every days trading of a particular security is independent of prior trading and reflects all current information about the security. Price may vary based upon speculation about future earnings, but past earnings is not a predictor of future earnings.
References for Weak Form Efficiency
Academic Research on Weak Form Efficient Market
Hurst exponent and prediction based on weak-form efficient market hypothesis of stock markets, Eom, C., Choi, S., Oh, G., & Jung, W. S. (2008). Hurst exponent and prediction based on weak-form efficient market hypothesis of stock markets. Physica A: Statistical Mechanics and its Applications, 387(18), 4630-4636. We empirically investigated the relationships between the degree of efficiency and the predictability in financial time-series data. The Hurst exponent was used as the measurement of the degree of efficiency, and the hit rate calculated from the nearest-neighbor prediction method was used for the prediction of the directions of future price changes. We used 60 market indexes of various countries. We empirically discovered that the relationship between the degree of efficiency (the Hurst exponent) and the predictability (the hit rate) is strongly positive. That is, a market index with a higher Hurst exponent tends to have a higher hit rate. These results suggested that the Hurst exponent is useful for predicting future price changes. Furthermore, we also discovered that the Hurst exponent and the hit rate are useful as standards that can distinguish emerging capital markets from mature capital markets. Testing the weak form of efficient market hypothesis: Empirical evidence from Asia-Pacific markets, Hamid, K., Suleman, M. T., Ali Shah, S. Z., Akash, I., & Shahid, R. (2017). Testing the weak form of efficient market hypothesis: Empirical evidence from Asia-Pacific markets. This empirical study is conducted to test the weak-form market efficiency of the stock market returns of Pakistan, India, Sri Lanka, China, Korea, Hong Kong, Indonesia, Malaysia, Philippine, Singapore, Thailand, Taiwan, Japan and Australia. Monthly observations are taken for the period January 2004 to December 2009. Autocorrelation, Ljung-Box Q-statistic Test, Runs Test, Unit Root Test and the Variance Ratio are used to test the hypothesis that the stock market follows a random walk. Monthly returns are not normally distributed, because they are negatively skewed and leptokurtic. In aggregate we concluded that the monthly prices do not follows random walks in all the countries of the Asian-Pacific region. The investors can take the stream of benefits through arbitrage process from profitable opportunities across these markets.
- Is the Saudi stock market efficient? A case of weak-form efficiency, Asiri, B., & Alzeera, H. (2013). Is the Saudi stock market efficient? A case of weak-form efficiency. The purpose of the paper is to test the weak-form market efficiency in Saudi Arabia's stock market, Tadawul, which is expected to follow a random walk. All share index and sectoral indices for daily closing prices in Tadawul between October 15, 2006 and November 15, 2012 are collected. The unit root Dickey-Fuller test, Pearson Correlation test, Durbin-Watson test, and Wald-Wolfowitz runs-test are used as basic stochastic tests for a non-stationarity of the daily prices for all the listed companies in the market, both overall and sector-wise. The four tests confirmed the weak-form market efficiency in the Saudi stock market for all share prices and eleven individual sectors. The findings are necessary for all investors in Saudi Arabia and the member states of the Gulf Cooperation Council (GCC). Listed firms could also benefit from the findings by seeing the true picture of their stock price. The finding is used as a basis for testing the market efficiency in the semi-strong form, which has not yet been tested by any researcher. Accordingly, investors in the Saudi market are not expected to generate abnormal returns simply by depending on past information and technical analysis. This paper will add value to the literature of market efficiency in the emerging market and the GCC; since it covers all the listed companies, tests sector-wise, and covers an extended period of time. To confirm the weak-form efficiency in Saudi, the study uses four tests and covers a long period of time during and after the financial crisis.
- Testing the Weak-Form Efficient Market Hypothesis: Using Panel Data from the Emerging Taiwan Stock Market, Nguyen, C. V., Chia-Han, C., & Nguyen, T. D. (2012). Testing the Weak-Form Efficient Market Hypothesis: Using Panel Data from the Emerging Taiwan Stock Market. International Journal of Business and Social Science, 3(18). This empirical study investigates whether the Taiwan Stock market is weakly efficient by modifying and estimating Dockery and Kavussanos multivariate model using a set of panel data. The Taiwan equity market is characterized as high-tech, one of the most liquid markets on the globe, well and strictly regulated, and in an advanced emerging economy. However, the empirical findings suggest that the Taiwan stock market is not informationally efficient, which may be attributable to the lack of broadness and depth of the market. The results further indicate that when the number of stocks included in the sample exceeds 5, the null hypothesis of the efficient market hypothesis is rejected throughout.
- Is the Mongolian equity market efficient? Empirical evidence from tests of weak-form efficiency, Lim, K. J. S., Chadha, P., Lau, J., & Potdar, N. (2012). Is the Mongolian equity market efficient? Empirical evidence from tests of weak-form efficiency. University Library of Munich, Germany. This paper investigates the empirical validity of the weak-form of the Efficient Market Hypothesis in the Mongolian equity market over Jan 1999 to Jul 2012. We examine the characteristics of the market by testing the fit of returns to a normal distribution using the Jarque-Bera Test, and find strong evidence against normality. The data also exhibits positive skewness and a high level of excess kurtosis. Next, we test for the presence of autocorrelation using the Ljung-Box Q Test and the non-parametric Runs Test, and find strong evidence against the null hypothesis of no autocorrelation for both of these tests. Finally, we test the associated Random Walk Hypothesis using the Augmented Dickey-Fuller Test and the Chow-Denning Multiple Variance Ratio (MVR) Test. We reject the null hypothesis of the presence of a unit root for the Augmented Dickey-Fuller Test. In addition, we find evidence against the Random Walk Hypothesis even after adjusting for the possible presence of heteroscedasticity in the MVR Test. Since all the tests present results consistent with weak-form inefficiency, we reject the weak-form of the Efficient Market Hypothesis for the Mongolian equity market.
- Weak-form efficient market hypothesis, behavioural finance and episodic transient dependencies: the case of the Kuala Lumpur stock exchange, Lim, K. P., Liew, V. K. S., & Wong, H. T. (2003). Weak-form efficient market hypothesis, behavioural finance and episodic transient dependencies: the case of the Kuala Lumpur stock exchange (No. 0312012). EconWPA. This study utilizes the windowed-test procedure of Hinich and Patterson (1995) to examine the data generating process of KLSE CI returns series. Unlike previous studies, the present one relates the evidence to the popular weak-form EMH and behavioural finance, with the hope of offering some plausible explanations to the controversy arises between these two camps. Our econometrics results indicate that linear and non-linear dependencies play a significant role in the underlying data generating process. However, these dependencies are not stable as the results suggest that they are episodic and transient in nature. Along the line of our interpretations, we are able to offer some plausible explanations as to why weak-form EMH generally holds in KLSE, though the presence of linear and non-linear dependencies implies the potential of returns predictability. Specifically, these significant dependencies show up at random intervals for a brief period of time but then disappear again before they can be exploited by investors. Looking from a micro perspective, we are able to rationalize the co-existence of weak-form EMH and behavioural finance in KLSE when the statistical properties of random walk, linear and non-linear dependencies, which also co-exist in the time domain, are interpreted in the framework of information arrival and market reactions to that information.
- Weak Form of Efficient Market Hypothesis ?? Evidence from Pakistan, Khan, N. U., & Khan, S. (2016). Weak Form of Efficient Market Hypothesis ?? Evidence from Pakistan. Business & Economic Review, 8(SE), 1-18. This research is an empirical investigation of the weak form of efficiency of the Karachi Stock Exchange (KSE-100) Index, which is the prominent index of Pakistan Stock Exchange (formerly Karachi Stock Exchange). The contribution of this paper is to analyze a longer 24 years' sample period (1991-2015) with three frequencies of data - daily, weekly and monthly index returns. The results show that return series of three frequencies have a negatively skewed, leptokurtic and non-normal distribution. The non-parametric Phillips-Perron (PP) test and parametric Augmented Dickey-Fuller (ADF) test rejected the non-stationarity hypothesis for index returns at the level for all daily, weekly and monthly data. The auto-correlation of randomness for the chosen period rejected the Random Walk Hypothesis (RWH) for daily and weekly index returns but documented the existence of RWH for monthly index returns. Lastly, the findings of run tests show market inefficiency on daily and weekly data and efficiency for monthly returns. The findings are not consistent with efficiency theory as the stock returns do not follow the random walk hypothesis and hence nullify weak form of efficiency for daily and weekly returns. However, the research documents weak-form of efficiency for monthly returns; the existence of randomness in monthly data is not surprising for an emerging market like Pakistan which does not have a long memory to remember previous monthly prices. Positioned upon weak form of efficiency assumption, the investors on the KSE can make abnormal returns on the basis of historical share prices (Malhotra, Tandon, & Tandon, 2015). The concept of market efficiency is important for analysts, for investor's investment decisions, and regulators of stock exchange to improve the flow of information. Further research can be done with more sophisticated techniques of testing weak form of efficiency
- Weak Form Efficient Market Hypothesis Study: Evidence from Gulf Stock Markets, Awan, U., & Subayyal, M. (2016). Weak Form Efficient Market Hypothesis Study: Evidence from Gulf Stock Markets. Ever Since Fama (1965) presented his Efficient Market hypothesis, a lot of research has been done to test its authenticity; developed as well as emerging economies are used to validate the theory. The results are conflicting and the change in the current market circumstances persuaded the researcher to investigate the Gulf Stock Markets. Data of six Stock Exchanges in Gulf for the period of five years is taken. Daily closing stock indices of Oman, UAE, Kuwait, Saudi Arabia, Bahrain and Qatar are taken from 1st January 2011 to 31 December 2015, Auto correlation and runs test were used to test the Weak Form Market Efficiency. The results of the Parametric Tests (Both Auto Correlation and Runs test) provide evidence that the Stock prices in all the Gulf Markets are not following the random walk model and the significant auto correlation co-efficient at different lags has rejected the null hypothesis of Weak Form Efficiency.
- An empirical analysis of the weak form efficient market hypothesis of the Nairobi securities exchange, Kamau, A. M. (2017). An empirical analysis of the weak form efficient market hypothesis of the Nairobi securities exchange(Doctoral dissertation). With the increased interest in the African economy, it is vital that we measure the performance of our capital markets to know where they stand. The Efficient Market Hypothesis (EMH) seeks to test whether a stock market is efficient in either the weak, semi-strong or strong form. With Kenya being an emerging market, the weak form efficient market hypothesis was put to test by the researcher, by determining whether successive daily stock market returns on the Nairobi Securities Exchange follow a random Walk or otherwise. The EMH briefly argues that for an efficient market, future share prices and returns should be random and unpredictable, such that any information regarding a stock is quickly assimilated into the market to reflect on the new share price. Data in the form of historical daily closing NSE 20-share Index from 1st January 2008 to 31st December 2012 was obtained from the Nairobi Securities Exchange. The use of a longer time period was to eliminate the thin trading bias that is characteristic of emerging stock markets, while the use of indices is to maintain consistency of data used in the research. Both parametric and non-parametric tests were used, to confirm results obtained in either of the tests. The data was analysed using STATA statistical package to test for stationarity of the model, normal distribution of stock prices, randomness of successive price changes and independence of stock price changes. Unit root test, runs test and Autocorrelation tests were carried out to test for the afore mentioned characteristics of the stock price and returns. Mixed results were obtained from the research, with the runs test concluding that the NSE daily market return series was random and therefore the NSE followed the random walk model. The autocorrelation tests and unit root tests, however, concluded the NSE was not weak form efficient. The autocorrelation tests detected serial correlation in the successive daily market returns and there was absence of a unit root in the time NSE time series. The research concluded that the NSE was not weak form efficient, since all the tests conducted did not conform to the characteristics of weak form efficient market hypothesis. Information flow from the listed companies to the public is not efficient, giving some investors an advantage over others. It was recommended after the study that the NSE should put policies in place to ensure informational efficiency and also educate the public on the advantages of investing in the stock market to improve trading on the bourse.
- The weak form efficient market hypothesis in the Nigerian stock market: An empirical investigation, Ikeora, J. E., Charles-Anyaogu, N. B., & Andabai, P. W. (2016). The weak form efficient market hypothesis in the Nigerian stock market: An empirical investigation. European journal of Business, Economics and Accountancy, 4(6). The study empirically examined the presence of weak form efficiency in the Nigerian stock market using time series data, 1985-2014. The data used to conduct this research is the All Share Index (ASI) converted to stock market returns. Time series econometrics techniques were conducted for the analysis. The study reveals that the large differences between the Mean and Standard deviation of the variables in the descriptive statistics suggest that the stock market is highly risky. The study shows that in the recent period, 2011 to 2014, it is found that stock returns are normally distributed. The results of the test of serial independence or randomness as obtained from Runs ADF tests show that in periods 1985 to 1992, 1993 to 1999, 2000 to 2010 and the whole period 1985 to 2014, the Nigerian stock market is dependent and not random thus inefficient, which indicate that investor can predict the markets returns. However, stock returns for period 2011 to 2014, market follow random walk, so investor cannot predict the market returns in the period. Finally, the result shows that previous stock market return has 15% positive relationship, and 0.23 0.23% predictive powers. Thus the study concluded that the NSE was not efficient in the
Empirical Test for Weak Form Efficient Market Hypothesis of the Nigerian Stock Exchange, Emenike Kalu, O. (2008). Empirical Test for Weak Form Efficient Market Hypothesis of the Nigerian Stock Exchange. Social Science Research Network (SSRN). Working Paper Series. In recent years, the Nigerian Stock Exchange (NSE) has witnessed an unprecedented growth in market capitalization, membership, value and volume traded. By December 2007, the All Share Index has grown massively to 57,990.2 from 1113.4 in January 1993. This rising interest in investment opportunities in the NSE raises questions about its efficiency. This paper, therefore, tests the Weak-form Efficient Market Hypothesis of the NSE by hypothesizing Normal distribution and Random walk of the return series. Monthly All Share Index of the NSE is examined from January 1993 to December 2007. Our Normality tests include Skewness, kurtosis, Jarque-Bera and Studentized Range tests; whereas Random walk is tested using the non-parametric Runs test. Results of the Normality tests show that returns from NSE do not follow normal distribution. Runs test results reject the randomness of the return series of the NSE. Overall results from the tests suggest that the NSE is not weak form efficient. Reduction of transaction cost so as to improve market activities and Minimizing institutional restrictions on trading of securities in the bourse were therefore recommended.