Academic journal article
By Pandey, Vivek K.; Kohers, Theodor; Kohers, Gerald
Academy of Accounting and Financial Studies Journal , Vol. 3, No. 1
The informational efficiency of financial markets has been an age old, yet intriguing topic of debate among finance theorists and practitioners. Random-walk tests employed in the past have established the weak-form efficiency of financial markets in most major industrialized nations. However, recent advances in the study of nonlinear deterministic systems have uncovered chaotic processes that can generate data series that may appear random to linear science. These discoveries have sparked a renewed rigor in the examination of capital market efficiency. Moreover, recent deliberations about viewing economies as evolutionary dynamical processes lend credence to the hypothesis that aggregate stock market behavior may be driven by a "vision of the future" (Grabbe 1996) and hence may embody an underlying deterministic mechanism. In light of these recent developments, investigations of underlying chaotic deterministic mechanisms in stock market aggregates has taken on an increased significance.
Grabbe (1996) presents the possibility of self-organization of human societies, and thus by implication of the economy, with a shared image or a vision of the future. At the singular level, this vision might be subconscious or nonexistent, but at the aggregate level such a vision might be discernible. In international stock markets, a large volume of the trading occurs while traders are speculating. They may not afford the luxury of acting late on any relevant news. Very often, the trader must anticipate other traders' moves and try to preempt such moves. As such, each trader must not just act on his or her expectations but rather act on anticipation of other traders' moves who themselves are trying to anticipate the first's and everyone else's moves and so on. Evolutionary dynamics provide a solution in the form of spontaneous order involving dynamic feedback at a higher, or aggregate, level. In the international stock markets context, what appears to be competition amongst traders and institutions at the lower level, where expectations are generated, functions as co-ordination at the higher (global) level. Hence it is likely that even in face of rational expectations, stock market aggregates, such as country market indexes used in this study, may be generated by some form of complex deterministic mechanism. As such market aggregates may not be priced efficiently in the traditional sense.
The subject of informational efficiency of U.S. financial markets continues to receive much attention in the literature (for examples, see Atkins and Dyl (1990); Ball and Kothari (1989)). More recent studies have begun the task of employing chaos theory in testing the efficiency of financial markets (e.g., Brock et al. (1987, 1991); Scheinkman and LeBaron (1989); Hsieh (1989, 1991, 1993, 1995); Kohers et al. (1997); Pandey et al. (1998) and Willey (1992)).
On the international level, several significant developments have created an increased interest in the efficiency of international markets. For example, relatively recent developments in financial market deregulation, the gradual lifting of restrictions on capital movements, the relaxation of exchange controls, major progress in computer technology and telecommunications, as well as a significant increase in the cross-listings of multinational company stocks have all led to a substantial rise in global stock market activities. Furthermore, the improvements in communication and computer technology not only have made the flow of international information cheaper and more reliable, but also have lowered the cost of international financial transactions. In addition, greater coordination in trade and capital flows policies among the industrialized nations may have contributed to more similar economic conditions and developments in these countries, which would be reflected in their respective stock markets. Largely as a result of these developments, many experts suggest that, especially in recent years, stock markets have moved toward a far greater degree of global integration, which has led to a renewed interest in the efficiency of foreign financial markets
In examining the pricing efficiency of stock markets, the vast majority of research has relied on linear modeling techniques which have serious limitations in detecting multi-dimensional patterns. …