Test of Market Efficiency

Topics: Stock market, Stock, London Stock Exchange Pages: 9 (2726 words) Published: March 28, 2011
1. Introduction

A well organized financial system can help any country to have a success economic development. And the well organized financial system also affects the market efficiency. Eugene Fama (1960) classifieds the market efficiency into three categories:

1> Weak Form of efficiency: if current stock prices reflect all the information that from market transaction data, this capital market will be regard as weak efficiency. 2> Semi Strong Form of efficiency: if the current stock prices not only reflect the all the information include historical prices but also all the information that are publicly available about the companies being studied. Besides the historical information, the public information also includes the fundamental data about company production, balance sheet, earnings forecast and some accounting information. 3> Strong Form of efficiency: if a stock price reflects all the information whether it is public or private (insiders’ information), the capital market is strong efficiency.

I choose Domino’s pizza, Carnival Corporation and Intercontinental Hotels Group from London Stock Exchange and collect the three companies’ share prices in three different 15 days. Meanwhile, the London Stock market prices in the three different periods are also collected. The London Stock Exchange is a stock exchange located in the City of London, London, United Kingdom. The Exchange is the fourth-largest stock exchange in the world and the biggest in Europe.

This report is testing the efficiency of London Stock market through a series of calculation of three companies’ share price. And these three companies are Domino’s pizza, Carnival Corporation and Intercontinental Hotels Group which are selected from London stock exchange. In this report, I will state my analysis methodology. In the second part, I will analysis the results that I calculated before to test the London Stock Exchange efficiency. In the conclusion part, the comparison between my hypotheses and the analysis result will be stated. After all my report, I will state a form that constituted by all the data I collected for calculation.

2. Literature Review
Jeffrey E. Jarrett and Eric Kyper state that market efficiency means a market price is capable to reflect all available information. The prices react instantaneously and unbiasedly to new available messages, and there is no trader can expect to gain more profit than others.

Eugene F. Fama had represented “The cleanest evidence on market-efficiency comes from event studies, especially event studies on daily return. When an information event can be dated precisely and the event has large effect on prices, the way one abstracts from expected returns to measure abnormal daily return is a second-order consideration. As a result, event studies can give a clear picture of the speed of adjustment of prices to information.” in The Journal of Finance

3. Analysis methodology
Efficiency hypothesis says that prices reflect information to be point where the marginal benefits of acting on information do not exceed the marginal costs (Jensen (1972)). How quickly and correctly the security prices reflect these event contained information show the efficiency of stock market.

The methodology that I use for testing London Stock Exchange in this report is Event Study. An event study is a statistical method to assess the impact of an event on the value of a firm. A capital market is said to be efficient with respect to corporate event announcement, such as stock split, buyback, right issue, bonus announcement, contained information and its disseminations. The basic idea is to find the abnormal return attributable to the event being studied by adjusting for the return that stems from the price fluctuation of the market as a whole.  There are several steps should be used to test market efficiency. 1> Select several companies in a same stock market. In my report, I choose Domino’s...
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