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Non‐linear Error Correction and the Efficient Market Hypothesis: The Case of German Dual‐Class Shares

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  • Jörg Breitung
  • Christian Wulff

Abstract

The efficient market hypothesis implies that (risk‐adjusted) asset prices cannot be cointegrated. On the other hand, arbitrage processes prevent prices of fundamentally related assets from drifting too far away. An attractive model that reconciles these two conflicting facts is the non‐linear error correction mechanism (ECM). Such a process tolerates small deviations from the long‐run relationship. For more substantial deviations, an effective adjustment process pushes the diverging prices towards their fundamental relationship. In this paper parametric and non‐parametric techniques are employed to investigate the ECM between prices of voting and non‐voting stocks. Despite its intuitive appeal, we find little evidence for a non‐linear relationship between German dual‐class shares. Only in four out of 12 cases does the threshold ECM yield a substantial improvement of fit. In other cases, the evidence for non‐linearity is rather weak and the threshold ECM fails to outperform the linear model.

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  • Jörg Breitung & Christian Wulff, 2001. "Non‐linear Error Correction and the Efficient Market Hypothesis: The Case of German Dual‐Class Shares," German Economic Review, Verein für Socialpolitik, vol. 2(4), pages 419-434, November.
    • Handle: RePEc:bla:germec:v:2:y:2001:i:4:p:419-434
    DOI: 10.1111/1468-0475.00047
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    2. Bayer, Christian, 2008. "On the interaction of financial frictions and fixed capital adjustment costs: Evidence from a panel of German firms," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3538-3559, November.

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