Testing the Weak Form of Efficiency of Karachi Stock Exchange

Topics: Stock market, Stock exchange, Fundamental analysis Pages: 14 (4702 words) Published: May 7, 2013
Pak. J. Commer. Soc. Sci. 2012 Vol. 6 (2), 297-307

Testing the Weak Form Efficiency of Karachi Stock Exchange
Muhammad Arshad Haroon Assistant Professor of Commerce, Government Sindh College of Commerce and Post, Graduate Center, Hyderabad, Adjunct Assistant Professor of Commerce, Isra University, Hala Nakka, Hyderabad, Pakistan E-mail: arshad.haroon@isra.edu.pk Abstract In an efficient market, share prices reflect all available information. The study of efficient market hypothesis helps to take right decisions related to investments. In this research, weak form efficiency has been tested of Karachi Stock Exchange—KSE covering the period of 2nd November 1991 to 2nd November 2011. Descriptive statistics indicated the absence of weak form efficiency while results of non-parametric tests, showed consistency as well. We employed non-parametric tests were KS Goodness-of-Fit test, run test and autocorrelation test to find out serial independency of the data. Results prove that KSE is not weak-form-efficient. This happens because KSE is an emerging market and there, it has been observed that information take time to be processed. Thus it can be said that technical analysis may be applied to gain abnormal returns. Keywords: Weak form efficiency, KSE, Random walk theory. 1. Introduction Stock markets are considered as a barometer of the economy Dholakia (2009); because stock markets facilitate investment related activities. For this reason there can be seen great interest on stock return processes and investors continuously work to find out the ways that will turn in handsome return. There is wide amount of literature on market efficiency and great debate over financial management and therefore, on market efficiency to cope up with financing and investing in stock markets. The notion of efficiency in stock market helps to understand the working mechanism of capital markets and taking right decision related to investment. Basically market efficiency is used to show the relationship between share price and information available on it. The roots of the concept of stock market efficiency can be found in random walk hypothesis which was presented by Bachelier (1900); under the heading of “The random character of stock market prices” which proves that prices of past, today and even future have no correlation, they follow randomness. According to this theory information on share prices are processed so rapidly that it becomes impossible to have abnormal returns fully nullifying the assumptions of technical analysis. This work was extended by Fama (1965) by proposing the theory; efficient market hypothesis. The theory states that market is considered to be efficient if it quickly process its information. There exists perfect competition, following strategy of fair game. Any events or rumors do not have any long

Testing the Weak Form Efficiency of KSE

lasting effect upon share prices. Prices adjust themselves so quickly that, no one can beat the market. Tests of the market efficiency are essentially tests of whether the three general types of information- past prices, other public information, and inside information-can be used to make above-average returns on investments. In an efficient market, it is impossible to make above-average return regardless of the information available, unless abnormal risk is taken. Moreover, no investor or group of investors can consistently outperform other investors in such a market. Professor Fama proposed Efficient Markets Hypothesis— EMH at three levels. They are Weak Form Efficiency, Semi-strong Form Efficiency, and Strong Form Efficiency. Figure: 1

As it can be seen from the figure 1, each successive level includes the previous one as well. EMH at weak form cannot be used to predict the future of past price. It states that price changes are random. In other words it can be said that it rejects technical analysis. This level can be tested by using run test, auto-correlation, and goodness of...
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