What can price volatility tell us about market efficiency? Conditional heteroscedasticity in historical commodity price series |
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Authors: | P??ter F?ldv??ri Bas van Leeuwen |
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Institution: | (1) Faculty of Economics and Business Administration, University of Debrecen, Debrecen, Hungary;(2) Faculty of Humanities, Utrecht University, Utrecht, The Netherlands;(3) Faculty of Humanities, Free University Amsterdam, Amsterdam, The Netherlands |
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Abstract: | The development in the working of markets has been an important topic in economic history for decades. The volatility of market
prices is often used as an indicator of market efficiency in the broadest sense. Yet, the way in which volatility is estimated
often makes it difficult to compare price volatility across regions or over time for two reasons. First, if prices are non-stationary,
the variance is inflated. Second, the variance of commodity prices contains information on a number of region- and time-specific
factors that are not related to market efficiency. Hence, the popular coefficient of variation and related indicators are
not adequate measures of the efficiency of markets and are incomparable across regions. As a solution, we suggest using a
conditional heteroscedasticity model to estimate the residual (conditional) variance of commodity prices. This measure reflects
how markets react to unexpected events and can therefore be seen as a measure of market efficiency. Using this approach on
grain prices from the Early Modern Pisa, Paris, Vienna, and Japan, we find that the residual price volatility had declined
(and market efficiency increased) in the European markets in the late sixteenth century while it remained stable in Japan. |
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