Recent literature puts forward the case for a generic random walk type model, offering a less stringent assumption than those imposed in earlier literature on market efficiency. Traditionally, the analysis has been whether one serves as covariance stationary and displays the property of short-memory or non-stationary and non-mean reverting. In exhibiting a form of memory, the market is thus not consistent with weak form efficiency.
Recent literature also focuses on the non-stationary nature of time series, with increasing attention focusing on the issue of whether series that appear integrated of order (< 0) are actually non-linear stationary series. In testing these current thought processes, one can determine if the market is in fact weak form efficient. In order to identify the current trends in this area of research and discover the likeliest area of application, the following literature review is submitted.
Sources were chosen based on area of research, applicability to hypotheses chosen, and to identify any gaps in the base of knowledge. The literature reviewed below briefly examines the theory of EMH from its inception through to today. In delineating the “line in the sand” between the two factions of efficient or inefficient, the research done clearly shows a path for further study and that research’s applicability.
In light of the literature reviewed, this study will research the validity of weak form efficiency in the London Stock Exchange, UK using current ideals and suggestions. Fama (1965) began his seminal work by looking into the Random Walk Theory of securities exchange. He argued that weak form efficient stock returns prove to be independently and identically distributed implying that they should follow a random walk and that future returns should not be able to be predicted using past returns.
By the early 1970’s a consensus had emerged among financial economists suggesting that stock prices could be well approximated by a random walk model and that changes in stock returns were basically unpredictable. Fama (1970) provides an early, definitive statement of this position. Historically, the ‘random walk’ theory of stock prices was receded by theories relating movements in the financial markets to the business cycle.