Volatility Tests and Efficient Markets: A Review Essay
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NBER Working Paper No. 3591 (Also Reprint No. r1701)
Issued in March 1992
NBER Program(s): EFG ME
This essay examines what volatility tests tell us about the data and what implications we should derive from them. It argues that volatility tests do not tell us that "prices are too volatile", implying that "markets are inefficient", but rather that "(discounted) returns are forecastable", implying that "current discount rate models leave a residual". It also argues that the discount rate residuals documented by volatility tests (and equivalent return forecasting regressions or Euler equation tests) are suggestive of rational, business cycle-induced discount rate movements, rather than "fads" or other inefficiencies.
Published: Journal of Monetary Economics, Vol. 27, pp.463-485, (1991).
This paper is available as PDF (440 K) or DjVu (226 K) (Download viewer) or via email.
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