Testing Weak Form Efficiency of Muscat Security Market - Literature review Example

Testing weak form efficiency of Muscat security market Contents Contents Introduction 2 Introduction Whenever a person puts money in the stock market their goal is not only to make profit but to outperform the market. However Eugene Fama suggested in his theory of efficient market hypothesis that at any given point of time all the information are readily available to everyone in the market. So it is not possible to outperform the market at any given point of time. What Fama actually tried to suggest is that there is no asymmetry of information. Since there is no asymmetry of information and all information, not necessarily limited to financial information is available to everyone, so the markets become random and is not predictable in nature. However there has been criticism to the EMH as time and again it has been proved that people have outperformed market. There are various degrees of efficiency- Strong- This states that all information available in the market is reflected on the stock price. Semi strong- All publicly available information is reflected on the stock price and one cannot beat the market based on fundamental or technical analysis. Weak- all past prices of stocks are reflected in the prevailing stock price available in the market. One cannot beat the market by technical analysis. Muscat stock market is the only stock exchange of woman that was formed by royal decree to regulate and control securities listed in Omani securities market. To ensure better functioning MSM was restructured by two royal orders. Literature Review Eugene Fama was first in coming out with Efficient market hypothesis theory which stated that it is no possible to outperform the market by selecting a group of stocks. Fama believed that all the information available in the market are readily available to all the investors and are reflected in the stock prices. This makes the stock prices unpredictable since the content of any particular news is unpredictable and not possible to know before the news actually comes out. Since stock prices are totally random so even if a blindfolded chimpanzee starts selecting a portfolio of random stocks, he has the same chance to make profit as any other expert. However in recent years there has been criticism of this theory and researchers in the field have come to believe that the stock prices are predictable, at least partially. However as per Malkiel (2003) stock markets are far more efficient and far less predictable than some other researchers have to say. Moreover there is overwhelming evidence that even if there might exist a possibility of anomalous behaviour in the stock market prices, the investor will not be able to earn extraordinary risk adjusted returns by exploiting this opportunity. However, according to Sekar and Arasu (2007) who tested the weak from of efficiency and applied it to the Indian Stock market found that the weak form of efficient market hypothesis does not apply to the Indian stock market. They found there in the Indian stock market there exists undervalued stocks and the investors could make excess profit by correctly picking them. Shiller (2003) is of the view that academic finance has evolved a lot since efficient market hypothesis was first suggested by Fama. There was a time when efficient market hypothesis was considered to be proved beyond doubt. However with the passage of time there has evolved a new branch of finance called behavioural finance. Behavioural finance considers finance from a broader perspective of social studies including psychology and sociology. Behavioural finance which has now become one of the most vital research wings stands in sharp contradiction with efficient market hypothesis. According to Mahmood, Xinping, Shahid & Usman (2010) who did their research in the Chinese market to find out whether the Chinese stock market is efficient or not and the impact of the global financial crisis on the efficiency of the Chinese market found that the Chinese stock market is at least weak form efficient and the past data on stock prices is not useful to make excess returns in the Chinese stock market. They also found that the global financial crisis had no significant impact on the efficiency of the Chinese stock market. Magnusson & Wydick (2002) in their research used data from eight largest African stock markets in order to test weak form of market efficiency. They compared it with the results generated from similar tests conducted in the Latin American and South East Asian markets. They concluded through their research that the rest results of weak of efficiency in the African stock market compare favourably with those performed on other stock markets in emerging countries. According to Cooray & Wickremasinghe (2007) who examined efficiency in stock market of India, Pakistan, Bangladesh and Sri Lanka found that weak form efficiency is supported by the classical unit root tests. However it is not strongly supported in case of Bangladesh under the DF-GLS and ERS tests. According to Asisri (2008) who tested weak form hypothesis in case of Bahrain stock market, it was found that the Bahrain stock exchange exhibited efficiency in the weak form. According to Sharma and Seth (2011) who did research on weak form of stock market efficiency in the two periods that is prior to the global financial crisis and after the global financial crisis found that Indian market do not exhibit weak form of market efficiency. It was also found that the global financial crisis did not have much impact on the behaviour of Indian stock market. Chen & Metghalchi (2012) found strong evidence from their research on the Brazilian stock market that the weak form of market efficiency strongly applies to the Brazilian stock market. Mlambo & Biekpe (2007) in their research on 10 African stock market found out that whereas some of the markets studied exhibited the presence of weak form of market efficiency, it was not applicable for the stock market of all the countries studied by the researchers. It was thus concluded by the researchers the possibility of making a profit by trading on historical stock prices cannot be entirely ruled out. Harper & Jin (2012) who did research on the Indian stock market to find out if it was efficient in the weak form found out that the Indian Stock market is not efficient in the weak form and the investors could exploit market inefficiency in order to make abnormal returns. Chong, Cheng and Wong (2010) compared stock market efficiency in BRIC countries such as Brazil, Russia, India and China found that the Brazilian market is the most efficient in the weak form among the BRIC countries. Chong, Li & Yu (2008) studied the structural changes in the efficiency of stock after the millennium. They found that the Moving Average Convergence and Divergence (MACD) trading rule performs well in the stock markets of Germany and Hong Kong. The research shows that generally the major stock exchanges across the world have become more efficient after the millennium than they were before. The stock market is considered essential for economic growth and is expected to contribute towards improved productivity. If the pricing mechanism of the stock marketplace is efficient then it can provide a driving strength for channelizing savings into gainful investments and thus facilitating optimal capital allocation. Hasan, Kamil, Mustafa & Baten (2012) found that the value of technical efficiency was high for investment group and low for bank group as compared with other groups in the DSE market. Cao, Liang, Lo, & Petrasek (2014) examined the relationship between changes in hedge fund holdings and the measures of informational equity prices efficiency that are derived from transactional data. It was found that on an average increase in ownership of hedge funds leads to noteworthy improvement in informational efficiency of equity prices efficiency. It is also found that the involvement of hedge fund to price efficiency is greater than the contribution of other types of institutional investors. However it is also found that the stocks that were held by the hedge fund experienced extreme decline in price efficiency during the liquidity crisis. The principal measure of the efficiency of a stock market is its information efficiency. This information efficiency is in turn closely related to the information available in the stock market. There is however a lack of definition of information from economic perspective as different researchers has different opinions on the information in the stock market. In his research Zou has used a relatively strict definition of information and has used this definition to derive the optimal conditions that are required to reach maximum information efficiency. Zou (2011) concludes that for information efficiency of stock market to be optimal, the market’s operation and information transmission mechanisms should be fully active and its information completeness degree should be optimal. Maberly & Pierce (2004) states, that over the past 20 years the stock return patterns in with respect to calendar time has been documented by financial economists. The research has focussed on analyzing stock return pattern with respect to month of the year (example January), day of the week (example Monday), etc. In their research Maberly & Pierce have focussed on Halloween effect to show that markets are inefficient. Previous researchers have often documented usually high monthly returns for both US listed stocks and foreign stocks during the months of November to April which they named as Halloween effect. Maberly & Pierce states that the anomaly which is being referred to as the Halloween effect actually represents an anomaly which could be economically exploited. They say that this revelation has a negative impact on the claims that markets are efficient. However if Bouman and Jacobsen’s empirical results are analyzed for the US it reveals that these results are driven by two different events crash of October 1987 and collapse of hedge fund in 1998. However it is also found that this anomaly is not economically exploitable for the US stock market. Stock market is associated with economic growth because it facilitates economic growth by providing new capital. Conversely economic growth also facilitates stock market growth. Lim, Huang, Lim & Zhao (2013) examined in their paper the efficiency of the two official stock markets in China and found through statistical evidence that the returns are correlated in both Shanghai and Shenzhen indexes and therefore it is found that the markets are weak from efficient. The responsiveness of the market financial instruments in respect of prices to reflect market information and the inability of information to out-perform other counterparts poses the quest to test whether strong form of market efficiency is applicable for the Nigerian stock market. Sulaiman and Azeez (2012) found out that strong form of market efficiency holds in the Nigerian capital market. It is also essential to perform stock volatility risk analysis to avoid substantial loss in the stock market. Nagata & Inui (2014) uses tick data on stock trades that were recorded with 1/1000- second stamp in order to investigate the effect of arrowhead- a high speed trading system on the Tokyo stock exchange since it was introduced in January 2010. They concluded through their analysis that Arrowhead had actually improved the average efficiency of the Tokyo stock exchange. It is also a possibility that the Arrowhead has obstructed rather than increasing efficiency of large trading sizes. Moreover it was also concluded that if the overall trading conditions are considered then it is very challenging for the investors who lack access to the latest high speed trading methods to substantially benefit from the increased efficiency. Urquhart (2013) in his research examined the impact of euro currency on the market efficiency of 10 of the most developed European stock markets during the period of 1988-2012. The results showed that the markets of Spain and Finland became more efficient after the introduction of Euro as a currency. On the other hand the market of France became more inefficient after the introduction of Euro as a currency. There were also markets of countries like Italy and Netherlands which were unaffected by the introduction of Euro. Overall they inferred through their results that the impact of Euro as a currency had mixed impact on the market efficiencies of different markets in Europe. Thus it could be concluded that the introduction of Euro was not a decisive factor in the stock returns of the European market. Kim & Shamsuddin (2008) in their research paper focussed on testing martingale hypothesis in the stock prices of a group of Asian markets. The researchers found out through their research that the Hong Kong, Japanese, Korean and Taiwanese markets had been efficient in the weak form. However the markets of Indonesia, Malaysia and Philippines showed no signs of market efficiency despite the implementation of financial liberalization since the 1980s. The researchers also found out through their research that the Singaporean and Thai capital market became efficient after the Asian crisis. The results of their research point towards the fact that the pricing efficiency of any market depends on the level of equity market development as well as regulatory framework conductive of transparent corporate governance. The Nigerian Stock exchange has experienced and witnessed growth in market capitalization, membership, value and volume traded like never before. By the December of 2007, the share index of NSE grew massively to 57,990.2 from a mere 1113.4 in January 1993. However the rising of interest in the investment opportunities in the domain of Nigerian stock exchange does raise question on the efficiency of NSE. Gimba (2012) wanted to test if the Nigerian stock market is efficient in the weak form but concluded through their analysis that the Nigerian stock market is inefficient in the weak form. As the empirical evidence suggests that the Nigerian market is inefficient in the weak form it can be conclusively said that anomalies in the stock return could exist in the market. So it is recommended that there should be reduction of transactional cost in order to improve market efficiency. It was also recommended to minimize institutional restrictions on trading of securities in the bourse. Dangol (2012) studied random walk behaviour and weak form market efficiency on daily market return of all share price index and sensitive index on the Nepal stock exchange. By their study they found out that there is no evidence of weak form efficiency in either of the series. It implied that market participants have opportunities to predict future prices and thus earn returns that were greater than the normal market return of the Nepal stock market. There has been tremendous development in the stock markets all over the world in the past decade. The 21st century has specially seen intriguing changes in the stock market in both the developed and developing countries across the globe. Ayentimi, Mensah & Naa-Idar (2013) examined in their paper the weak form efficiency of the firms listed on the Ghana stock Exchange. In order to do the analysis they apply the Random walk hypothesis using the weekly closing prices of the stocks listed in the GSE from Jan 2007 to June 2012. The GSE financial market returns series exhibits volatility by clustering which shows an indication of efficiency on the GSE. The results of both the weekly market returns and the normality tests showed that the returns from GSE did not follow normal distribution. The researchers recommend that in order to increase efficiency of the stock market of GSE transaction costs should be removed. Also GSE should try and get more firms listed on the stock market in order to enhance completion among different stocks. Market efficiency hypothesis suggest that the markets are efficient and the stock prices are a reflection of all the information that is available in the market. Due to the timely action of the investors prices of the different stocks adjust quickly in order to reflect the new information that is available in the market. So the Efficient market hypothesis says that no investor can actually beat the market by generating abnormal returns. However it is found in many stock exchanges of the world that they do not follow the rules laid down by EMH. The functioning of theses stock markets do deviate from the rules lay down by EMH. These deviations called anomalies could appear once and disappear or appear repeatedly Latif, Arshad, Fatima, & Farooq (2012) analyses the different types of anomalies with their evidences in different stock markets across the world. The paper also discusses the opinion of different researchers about the possible causes of anomalies and how they can be dealt with. References Asiri, B. 2008. Testing weak-form efficiency in the Bahrain stock market. International journal of emerging markets. 3(1). pp. 38-53. Ayentimi, D. T., Mensah, A. E., & Naa-Idar, F. 2013. Stock market efficiency of Ghana stock exchange: An objective analysis. International journal of management, economics and social sciences (ijmess). 2(2). pp. 54-75. Cao, C., Liang, B., Lo, A. W., & Petrasek, L. 2014. Hedge fund holdings and stock market efficiency. [Pdf] Available at. http://www.federalreserve.gov/pubs/feds/2014/201436/201436pap.pdf [Accessed on 29th December 2014] Chen, C. P., & Metghalchi, M. 2012. Weak-Form Market Efficiency: Evidence from the Brazilian Stock Market. International journal of economics and finance. 4(7). p.22. Chong, T. T. L., Li, C., & Yu, H. T. 2008. Structural change in the stock market efficiency after the millennium: the macd approach. Economics bulletin. 7(12). pp. 1-6. Chong, T., Cheng, S., and Wong, E. 2010. A Comparison of Stock Market Efficiency of the BRIC Countries. Journal of technology and investment. 1(4). pp. 235-238 Cooray, A., & Wickremasinghe, G. 2007. The efficiency of emerging stock markets: empirical evidence from the South Asian region. The Journal of Developing Areas. 41(1). pp. 171-183. Dangol, J. 2012. Stock market efficiency in Nepal. ZENITH international journal of multidisciplinary research. 2(5). pp. 40-48. Gimba, V. K. 2012. Testing the Weak-form Efficiency Market Hypothesis: Evidence from Nigerian Stock Market. Cbn journal of applied statistics. 3(1). pp. 117-136. Harper, A., & Jin, Z. 2012. Examining market efficiency in India: an empirical analysis of the Random Walk Hypothesis. Journal of finance & accountancy. 10(1). pp. 1-6. Hasan, M. Z., Kamil, A. A., Mustafa, A., & Baten, M. A. 2012. Stochastic Frontier Model Approach for Measuring Stock Market Efficiency with Different Distributions. Plos one. 7(5). e37047. Kim, J. H. & Shamsuddin, A. 2008. Are Asian stock markets efficient? Evidence from new multiple variance ratio tests. Journal of empirical finance. 15(3). pp. 518-532. Latif, M., Arshad, S., Fatima, M., & Farooq, S. 2012. Market efficiency, market anomalies, causes, evidences, and some behavioral aspects of market anomalies. Research journal of finance and accounting. 2(9-10). pp. 1-13. Lim, T. C., Huang, W., Lim, J. X. Y., & Zhao, D. 2013. Has Stock Market Efficiency Improved? Evidence from China. Journal of finance and economics. 1(1). pp. 1-9. Maberly, E. D., & Pierce, R. M. 2004. Stock market efficiency withstands another challenge: Solving the “sell in May/buy after Halloween” puzzle. Econ journal watch. 1(1). pp. 29-46. Magnusson, M., & Wydick, B. 2002. How efficient are Africas emerging stock markets?. Journal of development studies. 38(4). pp. 141-156. Mahmood, F., Xinping, X., Shahid, H., & Usman, M. 2010. Global financial crisis: Chinese stock market efficiency. Asian journal of management research. 1(1). pp. 90-101. Malkiel, B.G., 2003. The Efficient Market Hypothesis and Its Critics. Journal of economic perspectives. 17(1). pp. 59-82. Sekar, P.C. and Arasu, B.S. 2007. Indian stock market efficiency before and after the introduction of derivatives. Journal of contemporary research in management. 1(1). pp. 139- 154. Mlambo, C., & Biekpe, N. 2007. The efficient market hypothesis: Evidence from ten African stock markets. Investment analysts journal, (66), 5-18. Nagata, S., & Inui, K. 2014. Does High-Speed Trading Enhance Market Efficiency? Empirical Analysis on “Arrowhead” of the Tokyo Stock Exchange. The journal of trading, 9(4). pp. 37-47. Sharma, A. K., & Seth, N. 2011. Recent Financial Crisis and Market Efficiency: An Empirical Analysis of Indian Stock Market. Indore management journal, 2(4), 27-39. Shiller, R.J. 2003. From efficient market theory to behavioural finance. Journal of economic perspectives. 17(1).pp. 83-104. Sulaiman, L.A. and Azeez, B.A. 2012. capital market efficiency: a test of the strong form in Nigeria. Australian journal of business and management research. 2(3). pp. 12-18. Urquhart, A. 2013. The Euro and European Stock Market Efficiency. Journal of applied financial economics. 24(19). Zou, H. 2011. Information efficiency of stock markets. International journal of innovative management, information & production. 2(3). pp. 40-48. Read More