The Efficient Markets Hypothesis

Abstract

The importance of expectations in economic theory has been emphasised in chapters 1 and 2, and this importance is reflected in the empirical literature in economics involving expectations variables. In this chapter and the next we consider single-equation studies while macroeconomic models as a whole are examined in chapter 6. Because of the volume of published material covering expectations, we are necessarily selective in our review. Our emphasis is on breadth of coverage of results and methodology with special reference to the rational expectations hypothesis. First we review the econometric implications of expectations variables, and then consider in detail the efficient markets hypothesis. This is an example of implicit expectations where inferences about expectations are made from the data series. Applications to short-term interest rates, the term structure of interest rates and the foreign exchange market are presented. Other single-equation studies are reviewed in chapter 5 and cover the consumption function (where expectations are again implicit), and the wage equation and expected capital gains (where expectations are explicitlv modelled).