An Empirical Test of German Stock Market Efficiency
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An Empirical Test of German Stock Market Efficiency A Master Thesis submitted by Lindsay Gillette (188816) to Prof. Dr. Wolfgang Härdle in partial fulfillment of the requirements for the degree of Master of Science C.A.S.E. – Center for Applied Statistics and Economics Institute for Statistics and Econometrics Humboldt-Universität zu Berlin Berlin, Germany September 13, 2005 II Declaration of Authorship I hereby confirm that I have authored this master thesis independently and without use of other than the indicated resources. All passages, which are literally or in gen- eral matter taken out of publications or other resources, are marked as such. Lindsay Gillette September 13, 2005 III Acknowledgement I would first like to thank Prof. Dr. Wolfgang Härdle for giving me the opportu- nity to write this thesis as well as for his stimulating Statistics of Financial Markets course. I would also like to express my appreciation to the Quantitative Research Group of Bankgesellschaft Berlin for allowing me to perform the entirety of the re- search and writing required for this thesis in their office. Particularly, I would like to extend my sincerest gratitude to Peter Schmidt who offered his expertise and guid- ance on a daily basis. Furthermore, I would like to thank Dietmar Hillebrand for his feedback and insightful suggestions. Last but not least, I am extremely thankful to have such a wonderful family, thoughtful friends and a loving mother who have provided me with warm support and who have been nothing but encouraging and understanding throughout this experi- ence. IV Table of Contents List of Figures........................................................................................................... V List of Tables ........................................................................................................... VI Notation ................................................................................................................. VII Chapter I Introduction ...............................................................................................1 Chapter II Theoretical Foundations .........................................................................3 1 Market Efficiency...................................................................................................3 1.1 Random Walk Model.....................................................................................3 1.2 Efficient Market Hypothesis ..........................................................................4 1.3 Testing Market Efficiency..............................................................................5 1.3.1 Tests of Return Predictability .............................................................6 1.3.1.1 Time Patterns ........................................................................6 1.3.1.2 Predicting Returns From Past Returns ..................................7 1.3.1.3 Anomalies ..............................................................................7 1.3.1.4 Predicting Long-term Returns from Firm and Market Characteristics.......................................................................8 1.3.2 Event Studies .....................................................................................9 1.3.3 Testing for Strong Form Efficiency ...................................................10 1.4 Problems in Testing Market Efficiency........................................................11 1.5 Models to Measure Expected Return..........................................................12 1.5.1 Market Model ...................................................................................12 1.5.2 The Capital Asset Pricing Model (CAPM).........................................14 1.5.3 Multifactor Models ............................................................................20 Chapter III Empirical Analysis ................................................................................26 1.1 The CAN SLIM System............................................................................26 1.2 CAN SLIM Analysis of the German Market..............................................28 1.2.1 Investment Universe.........................................................................28 1.2.2 Initial Screening of CAN SLIM Factors..........................................29 1.2.3 CAN SLIM Preliminary Screening .................................................40 1.2.4 CAN SLIM Full Screening .............................................................46 Chapter IV Conclusion ............................................................................................50 Appendix ..................................................................................................................52 V List of Figures Figure II-1: Time Line for an Event Study...........................................................13 Figure III-1: BM and CDAX Return Indices. Left Y-axis for BM and CDAX, Right Y-axis for natural logarithm.................................................30 Figure III-2: Scatter plot of Data Used in Regression of Equation (III.1)..............32 Figure III-3: Same-Year Returns of CFS Growth-Ranked Portfolios....................33 Figure III-4: Price Momentum Regression using Equation (III.2) .........................35 Figure III-5: Price Momentum Strategy Implementation ......................................35 Figure III-6: Price Momentum Returns.................................................................36 Figure III-7: Returns of Long and Short Portfolios after the Annual CFS Growth Screen .............................................................................41 Figure III-8: Returns of Stocks Remaining after Accelerating CFS Growth Screen..........................................................................................43 Figure III-9: Returns of Stocks Remaining after Momentum Screen ...................45 Figure III-10: Unadjusted Discrete Returns to Investor of Individual Stocks in Final CAN SLIM Long and Short Portfolios for all Years 1985 - 2005..................................................................................47 Figure III-11: Market-adjusted Discrete Returns to Investor of Individual Stocks in Final CAN SLIM Long and Short Portfolios for all Years 1985 - 2005........................................................................48 VI List of Tables Table III-1: t-statistics for Same-Year Returns of CFS Growth-Ranked Portfolios......................................................................................34 Table III-2: t-statistics for Price Momentum Returns...........................................37 Table III-3: t-statistics for Portfolio Returns after Annual CFS Growth Screen..........................................................................................42 Table III-4: Number of Stocks Remaining after Annual CFS Growth Screen where t = Portfolio Building Year..................................................42 Table III-5: Number of Stocks Remaining after Accelerating CFS Growth Screen where t = Portfolio Building Year......................................43 Table III-6: t-statistics for Portfolio Returns after Accelerating CFS Growth Screen..........................................................................................44 Table III-7: Number of Stocks Remaining after Momentum Screen where t = Portfolio Building Year.............................................................44 Table III-8: t-statistics for Portfolio Returns after Accelerating CFS Growth Screen..........................................................................................46 Table III-9: t-statistics for Unadjusted Discrete Returns of Individual Stocks in Final CAN SLIM Long and Short Portfolios for all Years 1985 - 2005..................................................................................48 Table III-10: t-statistics for Market-adjusted Discrete Returns of Individual Stocks in Final CAN SLIM Long and Short Portfolios for all Years 1985 - 2005........................................................................49 VII Notation Symbol / Abbreviation Description ι ................................................................................................Column vector of ones Rm ........................................................................................ Return on market portfolio Rp ...........................................................................................Return on asset portfolio Ri ........................................................................................................Return on asset i rf ........................................................................................... Return on risk-free asset βi ............................................................................ Index of systematic risk for asset i β p ..........................................................................Index of systematic risk for portfolio APT ........................................................................................ Arbitrage Pricing Theory BGB......................................................................................... Bankgesellschaft Berlin BM ...............................................................................................................Benchmark CAPM .................................................................................Capital asset pricing model CFS ...............................................................................................Cash