Inefficient Market Hypotheses

  We often read in the newspaper that the dollar is strong because U.S. interest rates are high or that it is falling because U.S. interest rates are falling. Can these statements be explained using our analysis of the foreign exchange market? To answer this question, we again turn to a diagram. Figure 14-5 shows a rise in the interest rate on dollars, from R 1 to R 2 + + as a rightward shift of the vertical dollar deposits return schedule. At the initial exchange rate E 1 + > : , the expected return on dollar deposits is now higher than that on euro deposits by an amount equal to the distance between points 1 and 1 ′ . As we have seen, this difference causes the dollar to appreciate to E 2 + > : (point 2). Because there has been no change in the euro interest rate or in the expected future exchange rate, the dollar’s appreciation today raises the expected dollar return on euro deposits by increasing the rate at which the dollar is expected to depreciate in the future. Figure...

 The Efficient Market HypothesisONE OF THE early applications of computers in economics in the 1950s was to analyze economic time series. Business cycle theorists felt that tracing the evolution of several economic variables over time would clarify and predict the progress of the economy through boom and bust periods. A natural candidate for analysis was the behavior of stock market prices over time. Assuming that stock prices reflect the prospects of the firm, recurrent patterns of peaks and troughs in economic performance ought to show up in those prices.Maurice Kendall examined this proposition in 1953.1 He found to his great surprise that he could identify no predictable patterns in stock prices. Prices seemed to evolve randomly. They were as likely to go up as they were to go down on any particular day, regardless of past performance.At first blush, Kendall’s results were disturbing to some financial economists. They seemed to imply that the stock market is dominated by errati...