Weak-form Efficient Market Hypothesis, Behavioural Finance and Episodic Transient Dependencies: The Case of the Kuala Lumpur Stock Exchange Kian-Ping Lima, Venus Khim-Sen Liewb and Hock-Tsen Wongc a
Labuan School of International Business and Finance Universiti Malaysia Sabah P.O.Box 80594 87015 W.P. Labuan, Malaysia Department of Economics Faculty of Economics and Management Universiti Putra Malaysia 43400 UPM Serdang Selangor, Malaysia School of Business and Economics Universiti Malaysia Sabah Locked Bag 2073 88999 Kota Kinabalu Sabah, Malaysia
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Weak-form Efficient Market Hypothesis, Behavioural Finance and Episodic Transient Dependencies The Case of the Kuala Lumpur Stock Exchange
Abstract This study utilizes the windowed-test procedure of Hinich and Patterson (1995) to examine the data generating process of KLSE CI returns series. Unlike previous studies, the present one relates the evidence to the popular weak-form EMH and behavioural finance, with the hope of offering some plausible explanations to the controversy arises between these two camps. Our econometrics results indicate that linear and non-linear dependencies play a significant role in the underlying data generating process. However, these dependencies are not stable as the results suggest that they are episodic and transient in nature. Along the line of our interpretations, we are able to offer some plausible explanations as to why weakform EMH generally holds in KLSE, though the presence of linear and non-linear dependencies implies the potential of returns predictability. Specifically, these significant dependencies show up at random intervals for a brief period of time but then disappear again before they can be exploited by investors. Looking from a micro perspective, we are able to rationalize the co-existence of weak-form EMH and behavioural finance in KLSE when the statistical properties of random walk, linear and non-linear dependencies, which also co-exist in the time domain, are interpreted in the framework of information arrival and market reactions to that information. Keywords: Data generating process; Weak-form EMH; Behavioural finance; Kuala Lumpur Stock Exchange; Malaysia.
I. INTRODUCTION The efficient market hypothesis (EMH) introduced three decades ago was a major intellectual advance and reached its height of dominance in academic circles around the 1970s. Nowadays, it remains as one of the major building blocks of modern finance, evidenced by its inclusion in most finance and financial economics textbooks. Briefly, Fama (1970) defined efficient market in terms of a ‘fair game’ where security prices fully reflect all available information that is relevant to the determination of values. In this case, all securities are correctly priced and investors will earn a normal return on their investment that is commensurate with the level of risk assumed. One important implication is that security prices will change only when new information or ‘news’ arrives that was not fully considered in forming current market prices. Even so, in an efficient market, agents will process this new information efficiently by immediately incorporate it into security prices. The central question that requires careful dissection here is what constitutes ‘relevant information’. This is crucial because conclusions about market efficiency could differ according to what is included in, or omitted from the information set. Fama (1970) has outlined a standard classification for different compositions of information set, and with this, the EMH can be classified into weak form, semi-strong form and strong form. The author explained that such classification permits researchers to pinpoint the level of information at which the hypothesis breaks down. The weak-form EMH, which is the focus of this paper,...