Price Discovery in Asset Markets

Holbrook Working (1949) discovered that the percentage change in futures prices seemed to be largelyrandom. This led Paul Samuelson (1965) to develop the Efficient Market Hypothesis (EMH) which claims that the current spot and futures1 prices fully reflect all relevant information. Furthermore, because the future flow of information cannot be anticipated, price changes will not be serially correlated. These papers linked the notion of randomness of price changes to informational efficiency. From that point on, a major part of the empirical studies of asset markets has been the application of time series analysis to asset prices, in order to evaluate whether the price changes are random and whether futures prices reflect all available information. As the statistical tests became more sophisticated, the number of empirical studies increased and the results became more contradictory and difficult to interpret. An economic theorist can only be bemused by contemplating the empirical/econometric studies in the finance literature.