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Weak-Form Efficiency in Karachi Stock Exchange; Evidence from Random Walk Hypothesis

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Weak-Form Efficiency in Karachi Stock Exchange; Evidence from Random Walk Hypothesis A thesis submitted as the partial requirement for the degree of Doctor of Philosophy (Economics) by Ms. Musarrat Shamshir M.A.S. (Economics) Applied Economics Research Center, University of Karachi MSc. (Economics) University of Karachi Department of Economics, Faculty of Social Sciences University of Karachi, Pakistan February 2015 Declaration I hereby declare that the thesis, entitled, “Weak-Form Efficiency in Karachi Stock Exchange; Evidence from Random Walk Hypothesis,” contains no such material that has been accepted for the award of any other degree or diploma at any university or equivalent institution and that, to the best of my knowledge and belief, this thesis contains no material previously published or written by another person, except where due reference is made in the text of the thesis. This thesis includes two original papers published entitled, “Presence of Day-of-the-Week Effect in the Karachi Stock Market” and “Efficiency in stock markets; A review of literature”, in international peer reviewed journals. The subject matter of the thesis is based on weak-form efficiency of Karachi stock market. I am responsible for the idea and development of the thesis under the supervision of Prof. Dr. Khalid Mustafa. Musarrat Shamshir February 12, 2015. ii Department of Economics University of Karachi February 14, 2015 Approval of PhD Thesis This is to certify that Ms. Musarrat Shamshir, D/o Shamshir Ahmad (late) has completed her dissertation entitled “Weak-Form Efficiency in Karachi Stock Exchange; Evidence from Random Walk Hypothesis,” as the partial requirement for PhD degree, under my supervision. I allow her to submit her thesis for awarding the PhD degree under the set rules. Prof. Dr. Khalid Mustafa Chairperson, Department of Economics University of Karachi. iii Dedication Dedication I dedicate this thesis to my beloved parents (late), who believed in the richness of learning and had supported and encouraged me from the beginning of my studies. This thesis is also dedicated to my dearest uncle; Professor, Dr. Manzoor Ahmad, Ex-Rector, International Islamic University, who gave me the stimulus to start my PhD studies. He has been a great source of inspiration and a stirring mentor to me throughout my life. iv Acknowledgements Acknowledgements First and foremost, I am thankful to Almighty Allah for His countless blessings on me and for the strength, peace and hope to accomplish my objective. I would like to express gratitude to my PhD supervisor Professor Dr. Khalid Mustafa for his expertise, understanding and dedicated guidance throughout the research work. My sincere thanks also go to Dr. Shafiq ur Rehman, the Ex-Chairperson Department of Economics and Dr. Abuzar Wajdi for their encouragement and to Dr. Wali Ullah of IBA for his guidance and for the selection of econometric tools and procedures. I would also like to thank Syed Khalid Hussain, Director Business Development, ABL Asset Management Company for his contribution in making the daily data for KMI-30 index from 2009-2011 available to me, which otherwise turned difficult to find. Special thanks to Mirza Jawwad Baig, Assistant Professor, Institute of Space and Planetary Astrophysics, for his friendly support and scholastic guidance throughout my research work and publications. I would like to thank my colleagues Khubaib Ahmad, Syed Ghayas Tahir, Aun Ali, Syed Muhammad Raza and Dr. Riaz Somroo for their co-operation. My deepest gratitude goes to Prof. Dr. Mervyn Hosein, Ex-Principal Hamdard College of Dentistry; Dean Dentistry, Ziauddin University; for his enduring allure as a comforting and caring friend. He gave me strength and patience to continue my work especially when I was facing difficulties to manage the thesis writing with my time-bound job assignments. Without his intellectual and pedagogic stimulus, heartening spur and considerate behaviour it would not have been possible for me to complete my thesis. I am grateful to my loving husband Adnan Zaheer for all the support and care without which I would not have been able to achieve this phase of my life. He helped me in every respect and stood by me throughout the journey of my career development. I want to thank my very dear brother Khalid Shamsher; my two affectionate elder sisters, Rashida and Khalida; my darling nieces and nephews for their continuous emotional support and love. v Abstract Abstract The study is aimed at an empirical examination of the weak-form efficiency in Pakistani stock market within the framework of random walk hypothesis. The concept of weak-form efficiency of stock market initially was developed by Fama (1970), under the efficient market hypothesis (EMH), along with two other, strong and semi-strong forms. An efficient market is defined as where “stock prices fully reflect all available information. The efficiency of capital market is one powerful reason investors are so willing to invest in that market. Presence of even weakest form of efficiency in the stock market implies presence of random walk. The current study is based upon KSE, owing to its huge turnover as compared to the other stock exchanges in Pakistan. This particular study is based upon examining the four indices in the exchange and 43 companies selected on the basis of trading frequency of at least 95% days. The study adopted a triangular approach in methodology by using direct and indirect methods for exploring random walk. Directly random walk is tested by applying traditional tests; serial correlation, runs, Kolgomorov-Simirnov, autoregression, variance ratio and unit root tests and ARMA models. However, indirectly random walk is investigated by the presence of seasonal anomalies, volatility clustering, thin-trading and through non-linearity of return series. The empirical findings of the study conducted suggest that Karachi stock exchange does not exhibit weak-form efficiency and random walk for the majority of its firms and indices over the study period. The results reveal the presence of serial correlation and autocorrelation in the returns series of all indices and in most of the firms in the stock market. Similarly, stationary returns at level and non-stationary at difference also reveal the absence of random walk. Significant ARMA values also depict absence of random walk. Presence of anomalies and volatility clustering is found in majority of the indices and in firms. However, the study does support random walk in few of the selected firms and KSE-30 index and to some extent indication of random walk is found in KMI-30 index. Correspondingly, the absence of seasonal anomalies in KSE-30 and to some degree in KMI-30 index is credited to the free-floating methodology of shares in these indices. Similarly, the non-stationary return series of KSE-30 as depicted by unit root tests and GARCH models also supports the evidence of random walk in the index. Likewise, for variance ratio test and ARMA model the null hypothesis for random walk cannot be rejected for KSE-30 index. It is concluded therefore, that for KSE-30 index the evidence found in the study supports the weak-form efficiency. Hence, it can be said that KSE does not follow random walk with exception to KSE-30 index. Auxiliary research on KSE-30 index is however suggested by using a diversified approach and by analyzing weekly and monthly data for the corroboration of the results presented in the study. vi Urdu Abstract vii Table of Content Table of Content Chapter 1 Introduction to the Thesis ....................................................................................1 1.1 Introduction ......................................................................................................................1 1.2 Objective and Focus .........................................................................................................3 1.3 Outline of the Thesis ........................................................................................................5 Chapter 2 Economics of Efficient Markets and Random Walk ..........................................7 2.1 Concept of Efficient Market Hypothesis ..........................................................................7 2.1.1 Weak-form market efficiency ..................................................................................8 2.1.2 Semi-strong form market efficiency .........................................................................8 2.1.3 Strong-form market efficiency .................................................................................9 2.2 Relative Market Efficiency and Absolute Market Efficiency ..........................................9 2.3 Concept of Evolving Market Efficiency.........................................................................10 2.4 The Martingale Model ....................................................................................................10 2.5 The Random Walk Model ..............................................................................................11 2.5.1 Random walk 1 ......................................................................................................12 2.5.2 Random walk 2 .......................................................................................................13 2.5.3 Random walk 3 .......................................................................................................14 2.6 Importance of Efficient Market and RW Hypothesis on Economic Growth .................14
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