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1
P K Mishra, 2K B Das and 3B B Pradhan
1
Sr. Lecturer in Economics, Siksha O Anusandhan University, Bhubaneswar, India
Corresponding Author E-mail: pkmishra1974@gmail.com
2
Professor, Dept. of A & A Economics, Utkal University, Bhubaneswar, India
E-mail: drkbdas@gmail.com
3
Professor and Registrar, Siksha O Anusandhan University, Bhubaneswar, India
E-mail: registrar@soauniversity.ac.in
Abstract
The study of stock market efficiency has been the objective of many
researches across the globe since the last few decades. But the evidence is
mixed on whether the stock market is efficient. While some studies conclude
that the stock markets are efficient, other studies cast doubt on this conclusion.
Stock market efficiency suggests that stock prices incorporate all relevant
information when that information is readily available and widely
disseminated, which implies that there is no systematic way to exploit trading
opportunities and acquire excess profits. In other words, stock prices follow a
random walk which holds that stock price changes are independent of one
another. This paper is an attempt to provide some empirical evidence on the
efficiency of Indian stock market in the context of recent global financial
crisis. The study by employing the unit root tests on the sample of daily stock
returns, presents the evidence of weak form market inefficiency in India. The
study further examines the mean reversion implication of market inefficiency
and suggests the existence of mean reversion illusion in India.
Introduction
The stock market of India have witnessed a radical transformation in last the decade
or so owing to the judicious policy measures implemented through the financial sector
reforms of nineties. The adoption of international quality trading and settlement
mechanisms and reduction of transactions costs have made the investors, domestic
and foreign, more optimistic which in turn evidenced a considerable growth in market
volume and liquidity. The market features a developed regulatory framework, a
modern market infrastructure, removal of barriers to the international equity
investment, better allocation and mobilization of resources and increased
transparency. All these infer better efficiency of Indian stock market. Despite this
transformation, Indian stock market has recently shown greater volatility due to global
financial crisis which has affected the informational efficiency of markets. An
eventful year of great turbulence has begun in the Indian stock market scenario with a
continual fall in stock prices on news that Lehman Brothers, Merrill Lynch, and many
other investment bankers and companies collapsed. And, Indian stock market has seen
its worst time with the global financial crisis. Mostly all the industrial sectors
experienced a consistent low in their stock prices. The Sensex which had reached
historically high levels in the beginning of 2008, declined to its levels three years
back. Similar trend has also been observed for the S & P CNX Nifty. The movements
in Sensex and CNX Nifty between January 2007 and July 2009 are shown in Fig. 1(a)
and 1(b).
However, Indian stock market showed remarkable resistance to the winds from
the international financial implosion. Now, the stock market of India has returned to
its previous growth track in spite of a greater degree of volatility. In this context, it is
very much essential to study the efficiency of Indian stock market as the possibility of
undervaluation or overvaluation of a sizable amount of stock prices is there.
Empirical Evidence on Indian Stock Market 151
market has been showing an astonishing rebound. Thus, it seems that the global
market recession has influenced the stock market efficiency in India.
It is with this backdrop this paper examines the weak form efficiency of Indian
stock market in the context of global financial crisis. The organisational structure of
the paper is as follows: section II reviews related literature, section III discusses the
data and methodology of the study, section IV makes the analysis and section V
concludes.
Literature Review
The efficiency of stock markets is one of the most controversial and well studied
propositions in the literature of capital market. Even if there have been a number of
researches and journal articles, economists have not yet reached a consensus about
whether capital markets are efficient or not. The wide range of studies concerning the
efficient market hypothesis in the literature provides mixed evidences. The studies
such as Sharma and Kennedy (1977), Barua (1980, 1987), Sharma (1983),
Ramachandran (1985), Gupta (1985), Srinivasan (1988), Vaidyanathan and Gali
(1994) and Prusty (2007) supports the weak form efficiency of Indian capital market.
There have been some studies like Kulkarni (1978), Chaudhury (1991), Poshakwale
(1996), Pant and Bishnoi (2002), Pandey (2003) and Gupta and Basu (2007), (Mishra,
2009) and (Mishra & pradhan, 2009) do not support the existence of weak form
efficiency in Indian capital market. This disagreement regarding the Efficient Market
Hypothesis has generated research interest in this topic. Additionally, the recent
market downsizing across the globe has also contributed to it. Furthermore, this paper
shall fill the gap in the capital market literature by studying the weak form market
efficiency in the aftermath of global financial crisis.
Empirical Analysis
The empirical testing of the efficient market hypothesis in its weak form has been
performed by applying the PP and KPSS unit root tests. The results of these tests for
the sample period are summarized in Table-1.
For a Period from Jan 2007 to July 2009 PP Unit Root KPSS Unit Root
Test Test
Return Series Based on BSE Daily Sensex -23.14 [19] 0.14 [17]
30 Index
Return Series Based on NSE Daily Nifty -23.70 [20] 0.13 [17]
50 Index
The values within brackets refer to the bandwidth selected on the basis of Newey-
West criterion using Bartlett Kernel principle. The test statistics are significant at 1%
level of significance, and thus, null hypotheses of unit roots are rejected. It indicates
154 P K Mishra, K B Das and B B Pradhan
that the unit roots do not exist, and the series are stationary. This provides the
evidence that the stock markets of India do not show characteristics of random walk
and thus, are not efficient in the weak form.
Therefore, the opportunities of predicting the future prices thereby earning excess
profits exist in Indian stock markets. This opportunity of making excess profits
happens to provide incentives to market participants to introduce new financial
products to mobilise the savings of potential investors. As soon as these new financial
instruments appear in the market, they will generate greater efficiency in the
allocation of risks by breaking the links between origination and ownership, and by
creating new securities that can more finely allocate risks to different investor classes.
These innovations in the financial sector will undoubtedly bring efficiency in the
allocation of capital, reduce the cost of capital, and contribute to economic growth.
Thus, financial innovations in the emerging financial sectors of India as a whole are
beneficial. This does not mean that financial innovations are free of risks and
shortcomings. The recent global financial crisis is there to remind us that financial
innovations are mixed blessings.
Another aspect of stock market inefficiency is mean reversion. Poterba and
Summers (1988) concludes that the stock market is inefficient because prices are
mean reverting. If stock price follows a mean reverting process, then there exists a
tendency for the price level to return to its trend path over time, and investors may be
able to forecast future returns by using information on past returns. This tends to
make the market inefficient. In a very broad sense, stock market is mean reverting if
asset prices tend to fall (rise) after hitting a maximum (minimum). Using this
definition, many analysts can convince themselves that stock markets obviously mean
revert. For example, (so the thinking goes), the stock market was clearly overvalued
in the first quarter of 2008 in India. This overvaluation explains the subsequent falls.
In other words, mean reversion explains the stock market crash.
One can test this indication of mean reversion by regressing stock returns on past
stock returns (Engel and Morris, 1991). Such regression in Indian stock market over
the sample period yields:
Rt = 0.000089 + 0.074 Rt −1 for Stock Exchange, Mumbai, and
Rt = 0.00013 + 0.054 Rt −1 for the National Stock Exchange.
Here, the slope coefficient is positive for both the regressions. Thus, the stock
prices are not mean reverting. The indication of mean reversion as is evident from the
stock price movement in India, is therefore an illusion.
Conclusion
Since last few decades many researchers and analysts have been trying to examine the
efficient market hypothesis in the capital market of developed and emerging nations.
Despite their novel attempt, the hypothesis remains a controversial issue. The
economists have not yet reached a consensus about whether capital markets are
efficient or not. Thus, this paper focused on testing the efficient market hypothesis in
its weak form in Indian stock market in the context of global financial crisis. By
Empirical Evidence on Indian Stock Market 155
embarking upon the popular unit root test, the study provides the weak form
inefficiency of Indian stock market in the sample period. This market inefficiency has
several implications. First, the share prices may not necessarily reflect the true value
of stocks. So, companies with low true values may be able to mobilise a lot of capital,
while companies with high true values may find it difficult to raise capital. This
disrupts the investment scenario of the country as well as the total productivity.
Second, market inefficiency may imply mean reversion of prices that may cause
expected returns to vary. Third, market inefficiency may imply excess price volatility
in the short run because prices change by more than the value of the new information.
Last but not the least, weak form market inefficiency may have the positive impact on
the process of financial innovation. In a state of market inefficiency, opportunities for
supernormal profit exist because the future prices can be predicted following the
information contained in past prices. So the expectation for excess profit will
stimulate short run investment which may act as the best incentive for introducing
sophisticated new financial products to exploit the environment. Looking at the pros
of market inefficiency, one should say that it is a national virtue. The major problem
for the economy of an inefficient market is that investment funds are not channelled to
where they are most useful. This resource mal-allocation in the long run is destructive
as it would hinder the sustainable development of the economy.
References
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from Indian Capital Market. Vikalpa , Vol.6, No.2, pp.93-100.
[2] Barua, S. K. (1980). Valuation of Securities and Inflence of Value on
Financial Decision of a Firm. Doctoral Dissertation, Indian Institute of
Management, Ahmedabad.
[3] Barua, S. K., & Raghunathan, V. (1987). Inefficiency and Speculation in the
Indian Capital Market. Vikalpa , Vol.12, No.3, 53-58.
[4] Belgaumi, M. S. (1995). Efficiency of the Indian Stock Market: An Empirical
Study. Vikalpa , Vol.20, No.2, pp.43-47.
[5] Bhat, R., & Pandey, I. M. (1987). Efficient Market Hypothesis: Understanding
and Acceptance in India. Working Paper No. 691, IIM, Ahmadabad .
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Form Stock Market efficiency: The Indian Experience. Decision , Vol.35,
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NSE: An application of Runs Test. Journal of Accounting and Finance ,
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[8] Choudhury, S. K. (1991). Short-Run Share Price Behaviour: New Evidence on
Weak Form of the Market Efficiency. Vikalpa , Vol.16, No.4, 17-21.
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156 P K Mishra, K B Das and B B Pradhan