WEAK FORM MARKET EFFICIENCY AND INTEGRATION: EVIDENCES FROM SELECT ASIAN AND US MARKETS

Abstract

The stock markets play an important role in economic growth of developed as well as developing nations, as there is a long run relationship between stock market development and economic growth. The growing importance of stock markets around the world has attracted the researchers to work on different issues relating to the stock markets. To understand the functioning of the stock markets and to gauge the effectiveness of the pricing of the assets, the stock market efficiency is an important concept. New information takes the market into a particular mode and direction. It is a noted fact that movement of stock market is governed by the flow of information. For international diversification, another critical area for research is the unification of stock markets of different countries. The stock prices reflect all the relevant information and it would not be possible to forecast stock price in one market on the basis of any kind of transformation in another market. Further, stock markets are said to be integrated if they have tendency to move together in long run. This observation has activated the development and use of several tests of stock market efficiency and stock market integration. Referring to few researches done in past, co-integration implies inefficiency or efficiency implies absence of co-integration. The end of the year 2007 and the beginning of the year 2008 observed the arrival of the global financial crisis which had wrecked havoc in the financial markets around the world. This global financial crisis has led to new inspection and rejection of the EMH. Thus, on the basis of literature review, the objectives of this thesis are is to identify the change in the informational efficiency of selected Asian and US stock markets during the time periods under study with respect to the recent financial crisis. The second objective is to identify the change in the level of integration among the selected Asian and US stock markets during the time periods under study with respect to the recent financial crisis. The third one is to assess the relationship between efficiency and integration for selected Asian and US stock markets and the last objective is to depict the volatility change during the periods understudy for selected Asian and US stock markets considering the effect of the recent financial crisis. For the purpose of fulfilling the aforementioned objectives, the stock markets considered in the present study belong to the Asian and the United States (US) region. There are eleven stock iv markets that represent the Asian region and to represent US region, only one stock market; i.e., S&P, is taken. The stock markets in Asian region are emerging markets except Japan, South Korea, Hong Kong, Israel and Singapore and the emerging markets that are considered for this study from Asian region are India, China, Malaysia, Indonesia, Taiwan and Pakistan. A period of the twelve years, starting from 01/01/1999 to 31/12/2010 is used for the analysis. The period considered for the present study starts when the Asian financial crisis ends. The period of study ends till the last day of data collection. In order to provide the time varying results and to see the impact of recent global financial crisis, the total data set of twelve year period is further divided into four equal sub-periods. The four sub-periods are: sub-period-I; i.e., period after the 1997-98 Asian financial crisis from 01/01/1999 to 31/12/2001, sub-period- II; i.e., recovery period from 01/01/2002 to 31/12/2004. Sub-period-III; i.e., period before global financial crisis period (from 01/01/2005 to 31/12/2007), and sub-period-IV; i.e., period during 2008-2010 financial crisis period (from 01/01/2008 to 31/12/2010). The empirical results indicate that stock returns in the twelve markets are inconsistent with the weak form efficient market hypothesis (EMH). The output of the runs test shows the mixed results in context of market efficiency with the changing course of time. Beside runs test, other tests are also employed for further investigation. The results of unit root (ADF and PP) test show the existence of a unit root in all the twelve index series for the total time period as well as for the four sub-periods. The results obtained from the autocorrelation test also support the outcome obtained from the run test and the unit root test and the variance ratio test also depicts inefficiency in all the markets except a few incidences. The findings of correlation analysis show that the correlation between the markets is varying from very low to moderate. None of the markets was found to be highly correlated with others. The markets are found to be highly co-integrated in period-3. In line with the results of correlation and co-integration test, the ECM also shows that period-3 has the maximum number of markets with positive coefficients. In addition to this, the bidirectional causality among these stock markets is also highest in this period-3. It is again proved with innovation accounting technique that the markets pre-period are most robust markets that react to the other markets instantaneously but comes back to the equilibrium with the faster speed. After empirically examining the results of tests for efficiency, it is held that stock markets are inefficient. Thus, markets are co-integrated which is verified by the results of co-integration v tests. Hence, it is proved that stock market efficiency and stock market integration are inversely related. The GARCH (1,1) model was adopted to capture the volatility in the twelve stock markets taken into this study. Volatility clustering was found in these markets but the level or degree of volatility does not vary with the passage of time, more or less it remains same in first three periods. More specifically, the degree of volatility was highest in period-4 only where more markets have shown increasing volatility persistence as compared to previous three subperiods. The results shown in this research work has important implications for the transformation of the international financial strategies as a whole. The presence of inefficiency and the increase in the integration between the stock markets signifies a reduction in the diversification opportunities among the stock markets. Stock market integration does not allow the nations to use the international stock markets to diversify their capital and at the same time to hedge against the atypical adverse shocks like the recent financial crisis, especially when these shocks exists for a short while. The study on the subject matter is helpful in providing the information about the effect of international stock market integration and to use this as a base for determining the factors that determine the stock market prices and returns. Such empirical evidences plays very important role because the managers throughout the world can utilize these results to make decisions about the listing of their firm’s stocks; i.e., where and how many exchanges to have their stocks listed. This is for the reason that the share prices are the primary indicator of the shareholder’s wealth and the manager’s decisions may affect it. Apart from this, investors and policy makers should continuously look into the changing nature of short term relation or causality between the markets. They must assess the varying short term relationship of different Asian markets with US markets, to evolve short term investment strategies. This study can be extended further by developing formal speed of adjustment with which the new information is reflected in prices of individual stocks or portfolios. Inattention of the investor or any problem in the communication channel also contributes to the delayed reaction to information. So, future research effort may focus on suitable indicator for investor’s inattention. Since the present study is based on the Asian and US stock markets, the results of the study are indicative, and not conclusive, of the world stock markets in general. While the present study vi focuses on the effect of financial crisis on the market integration of the Asian and US stock markets. There are several other factors might be effecting the integration like nature of industry in the economy, investor’s behaviour, investment channels, use of technology etc., which are not studied in this thesis.