Market Efficiency

Market Efficiency- a case study of NSE Dr Saif Siddiqui Assistant Professor Centre for Management Studies Jamia Millia Islamia, New Delhi - 11025

Plan for Discussion

Efficiency and its Forms

Misconceptions of EMH

Testing Weak form of Market Efficiency

Case Study of selected NSE indices

S&P CNX Nifty

CNX Nifty Junior

Efficiency : defined

An efficient capital market is a market that is efficient in processing information…

In an efficient market, prices ‘fully reflect’ available information..

In 1960s and early 1970s

Fama (1965) concluded that

Most of the evidences are consistent with Efficient Market Hypothesis

Stock prices showed Random walk

Predictable variations in equity return were statistically insignificant

Reference:

Fama EF (1965) “The behaviour of stock market prices”. Journal of Business . 38:34–105

Forms of Market Efficiency

Fama (1970) defined three form of market efficiency :

Weak Form

Semi-Strong Form

Strong Form

Reference :

Fama, E F (1970): ‘Efficient Capital Markets: A Review of Theory and Empirical

Work’, Journal of Finance , 25, pp 383-417.

Weak Form

Weak form of efficiency implies that :

The current price reflects the past information or the history of prices.

Suggesting that charts and technical analyses that use past prices alone would not be useful in finding valuable stocks.

Semi-Strong Form

Semi-strong form of efficiency implies that

the current price reflects the information contained not only in past prices but all publically available information (financial statements/reports).

Strong Form

Strong form of efficiency implies that:

the current price reflects all information, public as well as private, and

no investors will be able to consistently find under valued stocks.

Misconceptions on EMH

No group of investors will beat the market in the long term .

Given the number of investors in markets, the laws of probability suggests that a fairly large number can beat the market consistently over long periods,

not because of their investment strategies but because they are lucky .

An efficient market does not imply that stock prices cannot deviate from true value ;

there can be large deviations from true value. The deviations do have to be random.

Fama’s new View

Fama (1998) suggests that apparent anomalies require:

new behavioural based theories of the stock market and

the need to continue the search for better models of asset pricing.

Reference:

Fama, E F (1998): ‘Market Efficiency, Long-term Returns, and Behavioural Finance’, Journal of Financial Economics , 49, pp 283-306 .

Testing Weak form of

Market Efficiency

Random walk hypothesis

Ko and Lee (1991),

If the random walk hypothesis holds, the weak form of the efficient market hypothesis must hold,

Thus, evidence supporting the random walk model is the evidence of market efficiency .

Reference :

Ko, K.S. and Lee, S.B. (1991) A comparative analysis of the daily behavior of stock returns: Japan, the U.S and the Asian NICs. Journal of Business Finance and Accounting , 18, 219-234.

Case Study- NSE

This study attempts, to seek evidence for the weak form efficient market hypothesis using the daily data for stock indices of the National Stock Exchange of India for the period of:

1 January 2000 to 31 Oct 2008

Research Methodology

Following test are done to analyze the data :

Jarque Bera Test

Unit Root Test

Autocorrelation test

Run Test

K-S Test

Descriptive Statistics

Analysis

Stock returns are not normally distributed,

Also verified with the Jarque-Bera statistic, which is a test statistic for testing whether the series is normally distributed.

The hypothesis of normal distribution is rejected at the conventional 5% level.

Unit Root Test

A test to determine whether a time series is stationary or not,

whether the null hypothesis of a unit root can be rejected.

ADF Test

PP Test

Analysis

The null hypothesis that there is a unit root cannot be rejected for both Nifty and Nifty Junior , in the level form.

For the first differences of both , the null hypothesis of a unit root is strongly rejected.

Both indexes contain a unit root , that is, non-stationary in their level forms, but stationary in their first differenced forms.

Runs Test

Runs Test is for the randomness of the series.

Runs test investigates serial dependence in share price movements

Run Test

Analysis

It can be seen that the total number of runs are 8 and 15 for S&P CNX Nifty and CNX Nifty Junior respectively.

Therefore, the hypothesis of randomness for both the series is rejected .

Autocorrelations

Autocorrelation is the correlation of a series with itself .The autocorrelation function (ACF) test is examined to identify the degree of autocorrelation in a time series.

Analysis