CMA Final · Strategic Financial Management · Efficient Market Hypothesis
A share's daily price changes over a long period show a serial correlation coefficient close to zero at all lags. A technical analyst claims profits can be made from trend-following rules. The most consistent conclusion under the Efficient Market Hypothesis is that:
Price changes are independent of each other, which supports weak form efficiency and the random walk model. Since past movements do not predict future ones, trend-following technical rules cannot consistently earn abnormal returns after costs.
- APrice changes are independent, supporting weak form efficiency and a random walkCorrect
- BPrice changes are strongly positive correlated, supporting momentum strategies
- CPrice changes are negatively correlated, supporting contrarian strategies
- DSerial correlation near zero rejects weak form efficiency
Explanation
Near-zero serial correlation means past price changes carry no information about future changes, which is the random walk and weak form efficiency. Trend-following rules therefore cannot earn abnormal returns. Options on positive or negative correlation contradict the data.
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