Stock prices and the money supply: Testing for informational efficiency

For a stock market to allocate funds efficiently, stock prices should immediately incorporate all of the information available. If we find that there is a lag between changes in variables that might affect the price of stocks, and the reflection of that change in its price, the market for stocks will be inefficient. This thesis tests the stock markets in six of the largest developed economies for informational efficiency. It tests the stock markets in Canada, France, Germany, Japan, The United Kingdom, and The United States, for the existence of a causal relationship between changes in the money supply and changes in stock prices, and applies the Granger-causality test to perform it. A stock market is informationally inefficient if a causal relationship between changes in the money supply and changes in stock prices is found. In this case, money supply changes could be used to predict movements in the prices of stocks, create profitable trading rules, and help us earn above-normal returns, thus casting doubts on the ability of the stock market to allocate funds efficiently.