Stochastic trends and stock prices: an international inquiry

Abstract

Several different tests are applied to check for the stochastic structure of individual stock indices in the United States, the United Kingdom, Canada, France, Japan, Italy and Germany. Using a log of monthly series (1953–89), results obtained indicate that all stock indices tested contain a stochastic trend (unit root). So it appears that shocks to the stock prices in the above countries are permanent rather than temporary. Presence of permanent shocks suggest that post World War II stock prices may not be predictable in the long run. The Johansen method of cointegration test is applied to check for common stochastic trends in a system of these stock indices. The cointegration test results do not support the presence of common stochastic trends among these stock indices. Thus, all tests results provide support for the efficient market hypothesis.

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