Introduction

The Center for Japan–U.S. Relations at the International University of Japan is currently planning to select, adapt, and develop practical techniques to study the informationally integrated capital markets of the United States and Japan. The analysis of a diversified portfolio of U.S. and Japanese stocks will require a simple, but operationally meaningful, frame work in order to test the informational efficiency of capital markets in both countries. Such a framework is also necessary for testing the effectiveness of macroeconomic policies. Defining a testable version of the efficient market hypothesis (EMH) will therefore occupy a central place in the center's initial research effort.

This chapter attempts to illustrate the basic assumptions of the EMH using some empirical evidence on U.S. and Japanese stock markets. These results were generated using a 20-year time series of monthly observations for the holding-period returns of the common stocks listed on the New York Stock Exchange and the Tokyo Stock Exchange. For each of the U.S. and Japanese stocks, we have selected comparable variables and time periods, and have used the same statistical techniques to ensure that the results for the two markets are comparable to the greatest extent possible.

Section 2 points out some theoretical issues raised by the EMH. In Section 3, five models commonly used in testing the EMH are briefly sketched. Section 4 summarizes a few studies on Japanese stocks and our empirical results.