he main objective of this thesis is to see whether value premium is present in the Indian stock market since the liberalization of it in the early 1990s. Additionally, I look into the reasons for the value premium – whether it can be explained by higher levels of fundamental risk and classical (also called modern) financial theory or can the reasons for market inefficiencies be based on irrationality of market participants and the groundwork of behavioral finance theorists. The concept of rationality in economic theory is also discussed.
My empirical research is based on the Bombay Stock Exchange Sensex index composed of 30 large capitalization and liquid stocks from major sectors of economic activity. After sorting the stocks to value and growth portfolios and analyzing the holding strategies of one, two and three years I report an existing value premium, however the statistical tests do not confirm it to be significant. Extreme persistent volatility in the returns and small data sample can partly explain such test results. I also find an indication of value stocks carrying more fundamental risk, yet only for some cases of portfolios sorted on Price to Book Value and Price to Cash Earnings ratios. Consequently, the behavioral finance theory is used to explain the reasons for the value premium found comparing value and growth portfolios sorted on Price to Earnings and Asset Growth financial ratios. Such factors as extrapolation, herding, overconfidence, framing, cultural differences, corporate governance and corruption are discussed as possible reasons for inefficiencies in the Indian stock market which lead to deviations from fundamental values and the existence of value premium.
Objectives of the Study:
The main objective of this thesis is to prove that value investing strategies outperform growth strategies in Indian stock market and to compare the findings to similar studies carried out by J. Lakonishok et al (1991, 1994, 2004), Fama and French (1992, 1998 and others) and others which report existence of value premium in such markets as USA, developed European countries, Japan and some of emerging markets. Since India is one of the major developing markets in the world now, it is interesting to see whether similar findings can be obtained here as so far I know of no similar research done on the data of stock markets in this country. I use a simplified version of method of J. Lakonishok et al (1994) while comparing the value and growth portfolios. Additionally, for explanations of the value premium I use a wide selection of behavioral finance theory in contrast to classical financial explanations and aim to get a better understanding of how markets work in general and how the concept of rationality is developing in economic theory. By analyzing the value premium and market inefficiencies, the goal is not only to create a study with precise empirical outcome, but also to try to understand and explain the main psychological, social, cultural and other behavioral factors driving the financial markets and what reasoning lies under the choices made by market participants. By trying to achieve above goals, I am also willing to get a better understanding of yet quite untouched by academic financial literature Indian market by reviewing its recent development and position in today’s world’s economy. The existence of value premium in Indian stock market would prove that it has similar movements to the rest of the world’s markets. Also, it would strengthen the idea that better performance of value stocks is not just sample related outcome and does not come from data mining.
The main purpose of this report is to find out if the value investment strategies produce better results than growth investment strategies in the Indian stock markets and the reason for that –whether it is greater risk or irrational choices...
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