PInformational efficiency of the markets invites the substantial attention of the financial scholars and practitioners. The understanding of the efficiency of the stock markets becomes imperative because of the increased flow of investments across international boundaries due to the integration of world economies. It is assumed to be an important concept for an extensive understanding of the capital markets. Stock market efficiency portrays the functioning of capital markets and their performance and contribution to the development of a country’s economy. Market efficiency is used to explain the association between the information and share prices in the market. Market efficiency influences the investment strategy of an investor because, if the market is efficient, then trying to pick up winners will be mere wastage of time. On the other hand, if markets are not efficient, excess returns can be made by correctly picking the winners. Traditionally more developed Western equity markets are considered to be more efficient.
In the last two decades, many emerging markets had initiated reform process to open up their economies. In the recent past, emerging markets have attracted foreign investment and became viable alternative for investors seeking international diversification. At present, thousands of intelligent, affluent, and well-educated investors are in the securities markets and they are interested in buying underpriced securities and selling over-priced securities.
In the ‘efficient’ market there will be large numbers of rational, profit seekers actively competing, with each other trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. The efficient market hypothesis is related to the random walk theory. Bachelier in 1900 (Poshakwale 1996)1 expounded the concept that asset prices may follow a random walk pattern. The random walk hypothesis explains that the successive price changes are independent of each other. In other words, in an efficient market at any point of time the actual price of a security will be a good estimate of its intrinsic value. (Eugene F. Fama 1965)2. The efficiency of the markets depends on the extent of absorption of information, the time taken for absorption and the type of information absorbed. Fama (1970)3 has first introduced the notion of capital market efficiency. Fama (1991)4 categorized market efficiency into three forms – weak, semi-strong and strong.
Weak – form efficiency: In its weak form efficiency, equity returns are not serially correlated and not have a constant mean. If the market is weak form efficient, security prices will reflect all the relevant information at any time and a trading rule based on the past prices will not be useful to identify mispriced assets. This form claims that any attempt to predict prices based on historical information are totally futile as future price changes are independent of past price changes. In the weak form efficient market, no investor can plan out a trading rule based solely on past price patterns to earn abnormal returns.
Semi-strong form: A market is semi – strong efficient if stock prices instantaneously reflect any new publicly available information. There are no undervalued or overvalued securities and thus, trading rules are incapable of producing superior returns. When new information is released, it is fully incorporated into the price rather speedily. In other words, fundamental analysis is of no use.
Strong – form: In the strong form efficiency all available information, even private information will be reflected in the security prices. Hence, the strong form does not hold in a world with an uneven playing field.
The Hypothesis of Market Efficiency is an important concept for the investors to hold internationally diversified portfolios. Efficient Market Hypothesis proposes that share price changes are unpredictable, i.e random. The Weak Form Efficient Market Hypothesis examines whether past series of share prices can be used to successfully predict future share prices or not. The more the investors and the quicker the dissemination of information, the more efficient a market should be. The lower the market efficiency, the greater will be the predictability of stock price changes. In an efficient market, information is freely available and the prices of the shares approximate to its intrinsic value. Successive price changes will be dependent if there is the gradual flow of new information. However, successive price changes will be random if the adjustment to information is almost immediate. Thus, price movements in a weak-form efficient market occur randomly and successive price changes are independent of one another.5 This test measures the statistical dependence between price changes. If there is no dependence between the past prices and the future prices (i.e., price changes are random), then the market supports Weak Form Efficient Hypothesis.
The empirical research on market efficiency has been done, in two broad categories, namely technical analysis and fundamental analysis. Technical analysis is used to examine the weak form efficient market hypothesis. The other is fundamental analysis, which assumes that factors other than past security prices are relevant in the determination of the future prices. The Weak Form Efficient Market Hypothesis can be examined into two sub- approaches: one is to determine the existence of predictability using past return series or price information. Another is to use technical trading rules if they can be exploited as profit making strategy.6
Voluminous literature is available on studying the behaviour of the stock price over time. In general, the results of previous research evidenced that the market of developed economies is generally weak form efficient. That means the successive returns are independent and follow the random walk. It is generally assumed that the emerging markets are less efficient than the developed market.
Studies on the developed market, supported the weak-form efficiency of the market considering a low degree of serial correlation and transaction cost (Working, 19347; Kendall, 19438, 19539; Cootner, 196210; Osborne, 196211; Fama, 196512). Groenewold and Kang (1993)13, Narayan and Smyth (2005)14. All of the studies supported the EMH that price changes are random and past changes were not useful in forecasting future price changes particularly after transaction costs were taken into account. Overall, the empirical studies on developed market sustain the weak-form efficiency of the EMH in general.
However, some other studies which rejected weak form efficiency in the developed markets are Fama and French, (1988)15; Poterba and Summers, (1988)16 Hudson, Dempsey and Keasey (1994)17 Kwan Sim, Cotsomitis (1995)18 Nicolaas, (1997)19
Though it is generally believed that the emerging markets are less efficient, the empirical evidence does not always support the notion. There are two groups of findings; the first group substantiates weak-form efficiency in developing and less developed markets. They are Branes, 198620, (on the Kuala Lumpur Stock Exchange); Chan, Gup and Pan, 199221, ( in major Asian markets) ; Dickinson and Muragu, 199422 (on the Nairobi Stock Exchange) and Ojah and Karemera 199923, (on the four Latin American countries market) Amanulla S. and Kamaiah .B 199724 (Indian stock market). Ramasastri A.S. 200025 (Indian stock markets) Pradhan H.K. and Lakshmi S. Narasimhan 200226 (Indian stock market) Hasan 200427 (Dhaka Stock Exchange). The estimated results show that the null hypothesis of randomness cannot be rejected and stock prices have a significant random walk or permanent component.
Whereas the others reject the weak-form efficiency in the developing and emerging markets are Roux and Gilberson 197828 (Johannesburg stock exchange) Claessens, Dasgupta and Glen 199529, (emerging markets) Sunil Poshakwale 199630 (Indian stock market) Nourrrendine Khaba 199831 (Saudi Financial market) Madhusoodanan 199832 (India stock market) Asma Mobarek and Kevin Keasey, 200033 (Dhaka Stock Exchange) Hyun-Jung Ryoo and Graham Smith 200034 (Korean stock market) Sarath P. Abeysekera 200135 (Colombo Stock Exchange) Sunil Poshakwale 200236 (Indian market). Chaudhuri and Wu (2003)37 Ibrahim Awad and Zahran Daraghma (2009)38
This study considers both traditional tests (such as, Kolmogorov Smirnov Goodness of Fit, Run test, Autocorrelation test and Ljung Box test ) and dynamic time series model (such as Dicky Fuller and Augmented Dicky Fuller model) which perhaps claims better findings.
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