Market Efficiency: An Empirical Analysis of KSE 100 Index

Topics: Stock market, Stock, Stock exchange Pages: 26 (2996 words) Published: September 22, 2013
Market Efficiency: An Empirical Analysis of KSE 100 Index
Haroon Mahmood
(Shaheed Zulfikar Ali Bhutto Institute of Science and Technology) haroonmahmood29@gmail.com
Dr. Kashif ur Rehman
Iqra University

Abstract
In an efficient market, the actions of the many
competing participants, leads to actual prices
already reflecting the effects of current
information and the actual price of a security to
wander randomly about its intrinsic value. The
fact that the market is efficient is important for
the public economy when it comes to the
distribution of scarce resources as it acts as an
intermediary of capital distribution from savers
to investors through the mechanism of price. In
Pakistan, securities market has a special
significance due to its sensitivity to political
turmoil, expectations, prospects of stocks and
insider’s information. With such indicators, it
only seems logical to test the efficiency of the
stock market in light of the existence of random
walk phenomena. In this study, historical stock

prices on a monthly and daily basis have been
used from a sample period of July 1996 to June
2006 of KSE 100 Index Companies. A time line of
10 years has been chosen to test the efficiency
of the Pakistani Stock market. Thus, the total
number of observations is 121 for monthly data
and 2218 for daily data. Consequently, ANOVA
method has been used to quantify the data. The
results conclude that the Random-walk
hypothesis can be accepted for both monthly
and daily returns. There is no “day of the week
effect” or the ‘month effect’. Thus, the random
walk theory is valid for the KSE which can be
termed as an efficient market.
Key Words
Efficient Market, Information, intrinsic Value,
Stock Price, Random-walk Hypothesis

1. Introduction
Capital markets play a vital role in mobilizing
indigenous resources and channel them
effectively for enhanced economic productivity.
Hence, the development of capital markets is
the prime determinant of a country's economic
growth (Bashar, 2002). Market efficiency is of
pivotal importance in any public economy when
considering the distribution of scarce resources,
as it performs an intermediary function of
capital circulation from savers to investors
through price mechanism. When it comes to the
allocation of capital to an unrestricted economy,
the stock prices should confer the correct signal,
i.e. containment of the complete set of
significant information. Hence, the public
economy requires the market to be efficient
(Claesson, 1987). Historically, many of the
statisticians and economists have argued about
the random walk theory in stock-market prices.
The followers of Random-walk theory usually
begin from the argument that the world's
established stock exchanges are good models of
“efficient” markets. In an efficient market, the
actions of the many competing participants,
leads to actual prices already reflecting the
effects of current information and the actual
price of a security to wander randomly about its
intrinsic value. Thus, a market where successive
price changes in individual securities are
independent is, by definition, a random-walk
market (Fama, 1995). The random walk theory
describes that current stock prices is the
reflection of all information, so, this can be
stated that a marginal time is required to
incorporate the new information in prices,
which provides a little time to the market
participant to make the most from this new
information in realizing abnormal profits. Due to
existence of homogeneity in information
system, the market participants are likely to be

obsessed to similar actions, thus discounting
the above-normal profit factor of any new
information to nominal average returns offered
by the market. Fama ( 1970), determined that
an efficient market is where stock prices be a
sign of the information in its entirety. So, the
prices following a random walk have no
possibility of...

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