The Evolution of Stock Market Efficiency in the US: A Non-Bayesian Time-Varying Model Approach

TL;DR

This paper introduces a non-Bayesian, time-varying model to analyze the evolution of stock market efficiency in the US, revealing cyclical fluctuations and periods of inefficiency linked to historical recessions.

Contribution

It develops a novel non-Bayesian, time-varying autoregressive model and a new measure of market efficiency to study its evolution over time.

Findings

US stock market efficiency fluctuates cyclically with 30-40 year periods.

Market was inefficient during four major historical recessions.

Results align partly with behavioral finance theories.

Abstract

A non-Bayesian time-varying model is developed by introducing the concept of the degree of market efficiency that varies over time. This model may be seen as a reflection of the idea that continuous technological progress alters the trading environment over time. With new methodologies and a new measure of the degree of market efficiency, we examine whether the US stock market evolves over time. In particular, a time-varying autoregressive (TV-AR) model is employed. Our main findings are: (i) the US stock market has evolved over time and the degree of market efficiency has cyclical fluctuations with a considerably long periodicity, from 30 to 40 years; and (ii) the US stock market has been efficient with the exception of four times in our sample period: during the long-recession of 1873-1879; the recession of 1902-1904; the New Deal era; and the recession of 1957-1958 and soon after it. It is then shown that our results are partly consistent with the view of behavioral finance.