Applied Financial Economics, 1998, 8, 167—174 Stock market prices, *causality+ and efficiency: evidence from the Athens stock exchange NIKITAS A. NIARCHOS * and CHRISTOS A. ALEXAKIS  *Department of Economics, ºniversity of Athens, 5 Stadiou str., 105 62 Athens, Greece and Department of Economics, ºniversity of Pireaus, Greece During the last few years there has been growing evidence against the Efficient Market Hypothesis. In this study we investigate the hypothesis using stock prices of common and preferred stocks from the Athens Stock Exchange. In Greece, preferred shares are regarded as part of the equity capital of the Greek companies and they are not considered as part of the borrowed funds. Under the Efficient Market Hypothesis their price behaviour, as far as the speed of adjustment to news is concerned, should be the same. However, our empirical evidence contradicts the above proposition. It seems that in the Greek market there are factors, other than news, which influence the price behaviour of the two categories of stocks. I. INTRODUCTION According to Fama (1976), a market is efficient if prices fully and instantaneously reflect all available information and no profit opportunities are left unexploited. In an efficient mar- ket there is a large number of rational profit maximizing investors, actively competing with each other, trying to predict future market prices of individual securities while important current information is almost freely available to all participants in the market. In an Efficient Market the competing market participants reflect information rationally and instantaneously on prices, making past rel- evant information useless in predicting future prices. An Efficient Market should react only to new information (‘news’), but since this is unpredictable by definition, price changes or returns in an efficient market, cannot be predicted. Under the Efficient Market Hypothesis we have P  !P*  /I  "u  (1) where I  is the information set available at time t!1, P*  is the expected price which is based on the information set I  , so P*  is uncorrelated with u  , and, additionally, the forecast error P  !P*  is uncorrelated with variables in the information set I  so that E [(P  !P*  )/I  ]"0 or E (u  )"0 (2) under the assumptions of a zero constant equilibrium return and risk neutrality. Tests for market efficiency usually examine whether the forecast error is uncorrelated with variables in the informa- tion set I  . According to the Efficient Market Hypothesis the best predictor of tomorrow’s price, which can be made on the information set I  , given today’s price, is today’s price. Thus, in an efficient market, the series of price changes, and consequently the series of stock returns, are uncorrelated with the variables in the information set I  . Fama (1970), distinguished three types of market effi- ciency. A market is said to be weak form efficient if past prices are useless in predicting future prices. A market is semi-strong efficient if all publicly available information like inflation, interest rates and earnings have no predictive power. Finally, a market is strong form efficient if all in- formation is reflected on prices, including the inside information. The main purpose of this study is to investigate whether it is possible to predict stock price changes or returns in the Greek Stock Market (i.e. Athens Stock Exchange) under the assumption of a constant equilibrium return. The Athens Stock Market (ASE) is an emerging small market with no adequate ‘depth’ and ‘width’ compared with other more developed stock markets worldwide. Further, this study was performed to shed more light on the workings of a small 0960—3107  1998 Routledge 167