Are European equity markets efficient? New evidence from fractal analysis

TL;DR

This paper uses fractal analysis on European and US stock indices to investigate market efficiency, finding evidence of long-range dependence in some markets that challenges the Efficient Market Hypothesis.

Contribution

It introduces a fractal analysis approach to assess market efficiency and examines the effects of prefiltering on detecting long-range dependence in stock returns.

Findings

Long-range dependence found in Italian and Czech markets.

Prefiltering can mask genuine long-range dependence.

Market efficiency appears to vary depending on prefiltering and the Hurst exponent.

Abstract

Fractal analysis is carried out on the stock market indices of seven European countries and the US. We find evidence of long range dependence in the log return series of the Mibtel (Italy) and the PX Glob (Czech Republic). Long range dependence implies that predictable patterns in the log returns do not dissipate quickly, and may therefore produce potential arbitrage opportunities. Therefore, these results are in contravention of the Efficient Market Hypothesis. We show that correcting for short range dependence, or prefiltering, may dispose of genuine long range dependence, suggesting that the market is efficient in cases when it is not. Prefiltering does not reduce significantly the power of the tests only for cases for which the Hurst exponent (a measure of the long range dependence) lies well outside the boundaries of no long range dependence. For borderline cases, the prefiltering procedure reduces the power of the test. On the other hand, the absence of prefiltering does not result in a test that is significantly oversized.