Stock Markets Efficiency and Volatility Tests: A Survey

Abstract: This paper provides a survey of two generations volatility tests of stock market efficiency, stressing both the economic and econometric aspects. The first-generation volatility tests from LeRoy/Porter (1981) and Shiller (1981) rejected the efficient market hypothesis, which are one of the first empirical evidence against market efficiency. It was found out that the initial volatility tests suffer some econometric flaws which make the test results unconvincing. The next-round volatility tests emphasized on developing tests that have acceptable econometric properties under realistic dividend models. With a small number of exceptions, the second-generation tests still found excess volatility, however the order of magnitude is smaller. Whether the constant rejection of the present value model is significant evidence against market efficiency is debatable. Several possible explanations are reviewed.;