Financial Market Risk

2 Competing financial market hypotheses

 

 

 

 

2.1 Introduction

Since Fama's (1970) martingale formulation of the Efficient Market Hypothesis (EMH), most textbooks in finance have blindly adopted this theoretical idealization of financial markets. However, the problem, in which a theoretical random process accurately describes the changes in the logarithm of a price in a financial market, is still open. Several competing models have been proposed to explain at least the following two stylized facts of observation:

(i) there is empirical evidence that the tails of measured distributions are fatter than expected for the classical Geometric Brownian Motion (GBM).

(ii) there is empirical evidence that the second moments of the relative price changes ...