Martingales, nonstationary increments, and the efficient market hypothesis

We discuss the deep connection between nonstationary increments, martingales, and the efficient market hypothesis for stochastic processes x(t) with arbitrary diffusion coefficients D(x,t). We explain why a test for a martingale is generally a test for uncorrelated increments. We explain why martingales look Markovian at the level of both simple averages and 2-point correlations. But while a Markovian market has no memory to exploit and cannot be beaten systematically, a martingale admits memory that might be exploitable in higher order correlations. We also use the analysis of this paper to correct a misstatement of the ‘fair game’ condition in terms of serial correlations in Fama’s paper on the EMH. We emphasize that the use of the log increment as a variable in data analysis generates spurious fat tails and spurious Hurst exponents.