Examining market efficiency in India: an empirical analysis of the Random Walk Hypothesis Alan Harper South University
Zhenhu Jin Valparasio University
This study tries to determine whether the Indian stock market is efficient by examining if the stock returns follow a random walk. Following previous studies, we use autocorrelation, the Box-Ljung test statistics and the run test and find that the Indian stock market was not efficient in the weak form during the testing period. The results suggest that the stock prices in India do not reflect all the information in the past stock prices and abnormal returns can be achieved by investors exploiting the market inefficiency.
Keywords: Autocorrelation tests, runs test, random walk hypothesis, stock index, India
If a market is efficient, stock price movements should follow a random walk and the price movements in the past should be not related to future price movements. But if the market is not efficient and price movements are not random, some investors can exploit the inefficiency by gaining abnormal returns. They may be able to correctly predict the future price movements by examining the historical price movements. There have been some studies testing the Efficient Market Hypothesis (EMH) in regards to the India stock market but the results have been inconclusive. This study analyzes the daily index returns from July 1997 to December 2011 by using some commonly used methodologies to determine whether the Indian market is efficient in the weak form. The Bombay Stock Exchange was established in 1875 is one of the largest exchanges in Asia and in the world. As of December 2011, the market capitalization on the Indian stock exchanges was $1.015 trillion, 5,112 companies were listed in the exchange with over 20 million shareholders. The paper is organized as follows. Section II provides a brief review of the literature. Section III provides the data, while section IV discusses the methodology. The paper concludes with the empirical results which are then followed by the conclusion.
The study of market efficiency can be traced to the seminal works of Fa a (1970). He
developed the three forms of market efficiency: weak form, semi-strong form and strong form. Since then many studies have been done to examine whether some markets are efficient in the weak form. For instance, Chan, Gup, and Pan (1992) analyzed the weak form hypothesis in Hong Kong, South Korea, Singapore, Taiwan, Japan, and the United States. Their findings indicate that stock prices in these major Asian markets and the United States are efficient in the weak form. But, Lo and MacKinlay (1998) use a variance ratio test to analyze the weekly returns of both the equally weighted and value weighted CRSP indices and find that stock prices do not follow a random walk. Gu (2004) also studied the weak form efficiency of the NASDAQ composite index by using of the variance ratio test from 1971 to 2001. Using daily returns, he finds evidence that the daily returns of the NASDAQ are not weak form efficient. In contrast, Seiler and Rom (1997) study the random walk hypothesis by using the Box-Jenkins methodology from 1885 to 1962 and find that historical stock price movements are random.
Several researchers have examined market efficiency in India but got co flicting results.
For example, Gupta and Basu (2007) evaluated market efficiency in the Indian stock market from 1991 to 2006. They use the ADF, PP, and KPSS procedures to test for unit roots. Their results indicate that Indian Stock Markets do not follow a random walk. Thomas and Kumar (2010) use the runs test and Kolmogorov-Smirnov test and find the same results using daily returns in the Indian Stock Market from 2004 to 2009. In a more recent study, Khan, Ikram and Mehtab (2011) used a runs test to analyze the daily returns from the BSE Sensex, the S&P CNX Nifty and various publications of...
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