Empirical Evidence of Weak Form Stock Market Efficiency

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Empirical Evidences on Weak Form Stock Market Efficiency: The Indian Exprience Ramesh Chander Kiran Mehta Renuka Sharma
Weak form efficiency hypothesis (EMH) stipulates that asset prices fully reflect information contained in past stock prices. The present study documents extensive evidence on price behavior in the Indian stock markets. One of the striking features of the results is that runs analysis too exuberate weak form efficiency further and the instances of return drift noted earlier have disappeared. On the whole, the results signify that trading strategies based on historic prices cannot be relied for abnormal gains consistently, except when these coincide with underlying drifts in the stock price movements. Key Words: Indian Stock Markets, Price, Weak Form Efficiency

Introduction Market efficiency is very contextual for investors under varied assumptions. It is extremely unlikely that all markets are efficient for all investors, but it is equally possible that a particular market (say, BSE) is efficient with respect to some investors under certain assumptions of differential tax rates and transaction costs. Market efficiency is also linked with similar assumptions about the spread and availability of information. Fama (1965) noted that markets could be efficient at three levels based on what information was reflected in prices. Under weak form efficiency, current stock prices reflect information contained in past prices, suggesting that charts and technical analyses based on past prices alone would not be enough to generate excess returns. Under semi-strong form efficiency, current prices are expected to reflect information contained not only in past prices, but also all public information including financial statements and news reports, and no approach based on using this information would be useful in finding undervalued stocks. Under strong form efficiency, current stock price is supposed to reflect all information, public as well as private, and no investor will be able to consistently outperform naïve investors through a buy and hold policy. Ramesh Chander is Reader and Chairperson, Department of Business Administration, Chaudhary Devilal University, Haryana India. e-mail: rameshchandra2005@rediffmail.com. Kiran Mehta and Renuka Sharma are faculty members of Department of Business Administration, Chaudhary Devilal University, Haryana, India.

Decision, Vol. 35, No.1, January - June, 2008

Empirical Evidences on Weak Form Stock Market Efficiency: The Indian Exprience


Thus, the efficient hypothesis (EMH) stipulates that at any given time, asset prices fully reflect available information in one form or the other. This seemingly straightforward proposition is one of the most controversial ideas in social science research, and its implication continues to reverberate through investment practices and is surprisingly resilient to empirical proof or refutation. The chief corollary of the idea that markets are efficient is that price movements do not follow any patterns or trends. This means that past price movements cannot be used to predict future stock prices. Rather, prices follow what is known as a ‘random walk’, an intrinsically unpredictable pattern. Origins of the Efficient Market Hypothesis (EMH) can be traced back to Bachelier’s (1900) pioneering theoretical contribution on random spirit of stock price movements and to the empirical research of Cowles (1933), which investigated predictability of stock price changes. The modern literature begins with Samuelson (1965) who provided solid theoretical base for the Efficient Market Hypothesis (EMH). The notion of an efficient capital market is based on the following set of assumptions. i) A large number of independent competing profit-maximizing participants to analyze and value securities; ii) New information regarding securities comes to market in a random fashion; iii) The market mechanism tends to adjust security prices rapidly to reflect the...
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