Question

Tests of market efficiency are often referred to as joint tests of two hypothesis. Explain the meaning of this. Would this pose any difficulty for tests of market efficiency?

Answer 1

Joint hypothesis are difficult to test the market hypothesis. This is for the reason that every hypothesis needs a pricing model, which could compare the actual price with the expected price. It is not possible to measure the abnormal returns which can compared with asset pricing model because these model doesn't give an expected abnormal returns to be compared with. Therefore the market return may not capture all the components and thus would not be able to price accurately.

This will pose difficult for market efficiency beacuse joint hypothesis complies that this is not testable because market efficiency incorporate all the information in the stock price but in real terms it is not correct because no pricing model can incorporate the abnormal returns.