Investments, tenth edition

  Weak-Form Tests: Patterns in Stock Returns 

  Returns over Short Horizons   

Early tests of efficient markets were tests of the 

weak form. Could speculators find trends in past prices that would enable them to earn 

abnormal profits? This is essentially a test of the efficacy of technical analysis. 

 One way of discerning trends in stock prices is by measuring the  serial correlation  

of stock market returns. Serial correlation refers to the tendency for stock returns to be 

related to past returns. Positive serial correlation means that positive returns tend to fol-

low positive returns (a momentum type of property). Negative serial correlation means 

that positive returns tend to be followed by negative returns (a reversal or “correction” 

property). Both Conrad and Kaul  

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   and Lo and MacKinlay  

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   examine weekly returns of 

NYSE stocks and find positive serial correlation over short horizons. However, the cor-

relation coefficients of weekly returns tend to be fairly small, at least for large stocks for 

which price data are the most reliably up-to-date. Thus, while these studies demonstrate 

weak price trends over short periods,  

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   the evidence does not clearly suggest the existence 

of trading opportunities.  

 While broad market indexes demonstrate only weak serial correlation, there appears to 

be stronger momentum in performance across market sectors exhibiting the best and worst 

recent returns. In an investigation of intermediate-horizon stock price behavior (using 3- to 

12-month holding periods), Jegadeesh and Titman  

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   found a    momentum  effect    in which 

good or bad recent performance of particular stocks continues over time. They conclude 

that while the performance of individual stocks is highly unpredictable,  portfolios  of the 

best-performing stocks in the recent past appear to outperform other stocks with enough 

reliability to offer profit opportunities. Thus, it appears that there is evidence of short- to 

intermediate-horizon price momentum in both the aggregate market and cross-sectionally 

(i.e., across particular stocks).