Market Efficiency: An Empirical Analysis of KSE 100 Index

Capital markets provide a function which facilitates the buying and selling of long-term financial securities to increase liquidity and their value, Watson & Head (2013). Hence, the Efficient Market Hypothesis (EMH) explains the relationship that exists with the prices of the capital market securities, where no individual can beat the market by regularly buying securities at a lower price than it should be. This means that in order to be an efficient market prices of securities will have to fairly and fully reflect all available information, Fama (1970). Consequently, Watson & Head (2013) believe that market efficiency refers to the speed and quality of how share price adjusts to new information. Nevertheless, the testing of the efficient markets has led to the recognition of three different forms of efficiency in which explains how information available is used within the market. In this essay, the EMH will be analysed; testing of EMH will show that the model does provide strong evidence to explain share behaviour but also anomalies will be discussed that refutes the EMH. Therefore, a judgment will be made to see which structure explains the efficient market and whether there are some implications with the EMH, as a whole.

In March 2015, Japan’s Financial Markets Agency for the first time in its history set out Corporate Governance Code and a year earlier Stewardship Code. Even though some efforts towards corporate governance and transparency have been made in Japan previously, specifically introduction of dual system in 2003, they did not gain popularity. Only 40 out of 3,000 firms adopted this system immediately rising to 112 five years later. However, these codes were necessary due to the pressure from foreigners investing and doing business in Japan, several scandals such as Olympus 2011-2012 accounting scandal and ineffective, high cash holdings of Japanese companies (Eberhart, 2012).

At the end of the stock market game the stocks that I own was Amazon, Wal-Mart, AutoZone, Ford, Kohls, Toyota, Coca-Cola, and O'Reilly. These stocks have done good since I have bought them. These stocks had their ups and down throughout the whole game, but although they didn’t have it that bad . They may have gained money, but, they also, losted money at the same time. Also, there were days where the stock price went up and down since there were people out there that was willing to pay for the stock at a higher price, but there were others that didn’t think it was worth it at a higher price.

Efficient Market Hypothesis has been controversial issues among researcher for decades. Until now, there is no united conclusion whether capital markets are efficiency or not. In 1960s, Fama (1970) believed that market is very efficient despite there are some trivial contradicted tests. Until recently, both empirical and theatrical efficient market hypothesis was being disputed by behavior finance economist. They have found that investor have psychological biases and found evidences that some stocks outperform other stocks. Moreover, there are evidences prove that market are not efficient for instance financial crisis, stock market bubble, and some investor can earn abnormal return which happening regularly in stock markets all over the world. Therefore, the purpose of this essay is to demonstrate that Efficient Market Hypothesis in stock (capital) markets does not exist in the real world by proofing four outstanding unrealistic conditions that make market efficient: information is widely available and cost-free, investor are rational, independent and unbiased, There is no liquidity problem in stock market, and finally stock prices has no pattern.

The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to

The efficient market hypothesis is constantly being analyzed for its validity in the current market. There are a multitude of external factors contributing to the reluctance of relying on the EMH. Specifically, the rise of high frequency trading has significantly called into question the legitimacy of the efficient market. High

In an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value. An efficient-market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where

Developing the efficient market hypothesis introduced by Fama, some contradicting studies were evolved that are called market anomalies which proves some deficiencies within the mentioned hypothesis

In 1960s, Efficient Markets Hypothesis was further developed by Paul A. Samuelson (1965) and Eugene F. Fama(1970). In an efficient stock market, the price for any given stock effectively represents the expected net present value of all future profits. Which means, according to the efficient markets hypothesis (EMH), market prices can reflect all available information. After that, the EMH theory becomes one of the pillars of modern financial economics theory.

The efficient market hypothesis (EMH) promoted by Fama (1970) is considered an important theory in financial area. However, the existence of momentum profits has threatened EMH.

The occurrence of stock market bubbles and crashes is often cited as evidence against the efficient market hypothesis. It is argued that new information is rarely, if ever, capable of explaining the sudden and dramatic share price movements observed during bubbles and crashes. Samuelson (1998) distinguished between micro efficiency and macro efficiency. Samuelson took the view that major stock markets are micro efficient in the sense that stocks are (nearly) correctly priced relative to each other, whereas the stock markets are macro inefficient. Macro inefficiency means that prices, at the aggregate level, can deviate from fair values over time. Jung and Shiller (2002) concurred with Samuelson’s view and suggested that waves of over- and

The phenomena behind equity risk premium discussion for 35 years, was first took place in Robert J. Schiller’s work done on volatility of equity prices. The research conduct by Schiller (1982), highlighted the difficulty of explaining the historical volatility of stock prices. The results of Shiller’s paper stunned the profession at first as most of economists felt discount rates were close to constant over time. The intuition behind the unpredictability of volatility, later named volatility puzzle by scholars who have studied this paradox as well. Just after 3 years from Schiller work on historical volatility, Mehra and Prescott (1985) introduced the equity premium puzzle. It is mainly based on the lack of evidence for a high risk premium in terms of consumption growth. In other words, investors require and have high returns which have low covariance with consumption growth. Using Schiller’s data collected on the volatility puzzle, they have found out that between 1889 and 1978, the consumption growth rate, the indicator for opportunity cost of investors is insufficient to explain 6% risk premium. Moreover, it was so high that the findings suggested only a risk premium of 0.35% on top of the risk-free rate. Behavioural finance approached this puzzle based on preference of investors. The decision making process of investors on investing on equities and why do they require high risk premium and fear equities this much. One of the leading papers on the

With the penetration of the research on the securities market, scholars have found many “abnormal phenomenon”, which is contrary to the Efficient Market Hypothesis(EMH) proposed by Eugene Fama, a professor of Finance at the university of Chicago Booth School of Business. The hypothesis was based on the efficient markets model after the proof of theoretical and empirical literature. Fama argued that stock prices has fully reflected all available information (mainly historical information about price changes, such as the previous stock price) in the efficient market and new information is unpredictable which makes the stock price changes follow a random walk. However, in weak-form efficiency market, investors can not rely on the analysis of the trend of historical changes of stock price to get the so-called law of change in the stock price and consistently obtain excess profits by it. If the weak-form Efficient Market Hypothesis is set up, the technical analysis of the share price become unhelpful anymore, and the basic analysis may also help the investors to gain extra profits. Numerous experimental tests on weak-form efficiency market hypothesis show that the market is basically inefficient after deducting trading costs. For

A STUDY ON STOCK MARKET RETURN, VOLATILITY AND CORRELATION ANALYSIS AMONG INDIAN & ASIAN STOCK MARKETS

The Bombay Stock Exchange (BSE) is one of the oldest exchanges crossways the world, while the National Stock Exchange (NSE) is among the best in terms of complexity and advancement of technology. The Indian stock market scene really picked up after the opening up of the economy in the early nineties. The whole of nineties were used to experiment and fine tune an efficient and effective system. The ‘badla’ system was stopped to control unnecessary volatility while the derivatives segment started as late as 2000. The corporate governance rules were gradually put in place which initiated the process of bringing the listed companies at a uniform level. This opening up of the system led to increased integration with heightened cross-border flow of capital, with India emerging as an investment ‘hot spot’ resulting in our stock exchanges being impacted by global cues like never before.