Question

Explain the limitations of (i) Variance Ratio test, and (ii) Box-Pierce Q test in assessing the concept of market efficiency.

Answer 1

Limitations of Variance Ratio test

1.It is designed to test against any and all alternatives to the null hypothesis and thus may be suboptimal for testing against a specific hypothesis.

2. It is not optimal always. It is optimal when losses are proportional to the square of the differences among the unknown population means, but may not be optimal otherwise. This is a limitation of this this method.

3.It is designed for use when the observations are drawn from a normal distribution but if the observations are heavier then this is not appropriate.

Limitations of Box pierce Q test

1. There is a multiple testing problem with this kind of test. It is occurd when one considers a set of statistical inferences simultaneously or infers a subset of parameters selected based on the observed values.

2. It only consider the auto correlation and result always depends on the observations only. So there should be adequate and accurate observations.

3. Difficulty in analysing the result is another limitation. It makes some confusions on the result interpretation.

Thankyou.....