Uniformly Least Powerful Tests of Market Efficiency
Tim Loughran
P.O. Box 399
University of Notre Dame
Notre Dame IN 46556-0399
Loughran.9@nd.edu
(219) 631-8432
and
Jay R. Ritter
Department of Finance
University of Florida
Gainesville FL 32611-7168
jay.ritter@cba.ufl.edu
(352) 846-2837
http://bear.cba.ufl.edu/ritter/index.html
September 22, 1999
forthcoming, Journal of Financial Economics
Abstract
Defenders of market efficiency argue that anomalies involving long-term abnormal returns are not robust to alternative methodologies. We argue that because various methodologies use different weighting schemes, the magnitude of abnormal returns should differ, and in a predictable manner. Three problems are identified that cause low power in value-weighted three-factor time series regressions when abnormal returns following managerial actions are being estimated. We illustrate the sensitivities in the context of the new issues puzzle, and with simulations. More generally, multifactor models as currently used do not, and cannot, test market efficiency.
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