Testing Weak form efficiency for Indian derivatives market

Introduction The Efficient Market hypothesis (EMH) assumes that stock prices adjust rapidly to the arrival of new information, and thus, current prices fully reflect all available information. Fama (1970) divided the efficient market hypothesis in to three categories, viz, Weak form efficiency, Semi strong from and strong form efficiency. The weak form EMH says that current market price of an asset (stock) fully reflects all historical market information such as prices, trading volumes and any market based information. In the Semi strong EMH prices includes not only the historical information but also all public information including non-market information such as earning and dividend announcements, economic and political news. And, in the strong from EMH all information from historical, public, and private sources are reflected in the prices of assets. Therefore, there is no any scope for the investors to make any extra return than the normal return. Stock market efficiency is an important concept, both in terms of an understanding of the working of stock markets and in their performance and contribution of the development of a countrys economy. If the stock market is efficient, the prices will represent the intrinsic values of the stocks and in turn, the scarce savings will be optimally allocated to productive investments in a way that benefits both individual investors and the country economy (Sapate and Ansari, 2011). Testing the efficiency of the market is very important for the investors, stock brokers, financial institutions, government etc. for understanding the functioning of the capital markets. An efficient market is one which does not provide any chance to the potential investor for earning abnormal profit as all the information is dispersed and absorbed in the market and is quickly and accurately reflected by the prices of securities. Therefore, there will be no undervalued securities offering higher than expected returns, considering the risk associated with them. The investigation of the validity of the EMH has been and still one of the favorite topics of the financial literature. A significant number of studies have examined the efficiency of stock markets using different methodological techniques like parametric tests include the autocorrelation test, LBQ test and the non parametric tests include the runs test. In Indian context the capital market efficiency has been studied by many authors giving importance to stock markets like National Stock Exchange (NSE) and Bombay Stock Exchange, Mumbai (BSE).

However, the studies which carried out to test EMH in Indian derivatives market are very limited in number. Therefore in this paper we try to test whether Indian derivatives market follows the efficient market hypotheses or not. The scope of this study is limited to only weak form of EMH. In Indian capital market commodity futures trading was permitted in the year 2003 and since then this market showed a remarkable growth. Total value of trading in the commodity futures market rose from Rs. 34,84,485 crore in 2006 to Rs. 36,54,487 crore during 2007 and similarly it has continuously increased to Rs. 94,94,725 crore in 2010. The average daily value of trades in the commodity exchanges improved from Rs. 15,000 crore during 2007 to Rs. 18,500 crore in 2008 and to Rs 23,200 crore in 2009. The total value of trade for the financial year 201011 was Rs.119.49 lakh crore as against Rs. 77.65 lakh crore in the preceding financial year, registering a growth of 53.88 % (Annaul Report 2010-11, Forward Market Commission, page12). The growth could be attributed to larger participation in the market, increase in global commodity prices, the advent of new commodity exchanges and the restoration of trade in some of the suspended agricultural commodities. Literature Review As mentioned in the introductory part plenty of studies have been carried out using different statistical models for testing EMH in India as well as in abroad. All these studies have displayed mixed results. Majority of the Indian studies concentrated only on efficiency of stock market. Sharma and Kennedy (1977), Ramachandran (1986), Poshakwale (1996) and Sharma and Mahendru (2009) are some major studies to name, who found the Indian stock market follows weak form efficient where as Pradhan B B and Mishra P K (2009), Pandey (2003) and Khan, Ikram and Mehtab (2011) found that Indian stock market was not weak form efficient. Sharma and Kennedy (1977) tested the random-walk model, by runs analysis and spectral densities, against representative stock market indexes of the Bombay, New York, and London Stock Exchanges. The three indexes examined were the Bombay Variable Dividend Industrial Share Index (BVDISI), consisting of 603 industrial stocks, the New York Standard and Poor's 425 Common Stock Index (S & P 425), and the London Financial Times-Actuaries 500 Stock Index (London F.T.-A.). The test period covered 132 monthly observations for each index for the 11-year period 19631973. They concluded that stocks on the BSE (Bombay Stock Exchange)

follow random walk and are weak- form efficient. Ramachandran (1986) used filter rule test, runs test and serial correlation test for testing the weak - form efficiency. For this purpose he used weekend prices of 60 scripts over the period 1976 to 1981 and he found support for the weak - form of EMH. Chaudhuri S. K. (1991) studied the weak form market efficiency using the serial correlation test and run tests and concluded that Indian capital market is not efficient in its weak form. This study used daily price quotations for 93 actively traded shares in the Indian stock market for the period January 1988 to April 1990. Poshakwale Sunil (1996) using serial correlation, run test, KS test tried to collect evidence for weak form of market efficieny for Bambay Stock exchange. He found that Indian capital market do not follow the weak form EMH. This study covered for the period of 1987 to 1994. Bhanu Pant and T. R. Bishnoi (2002) the behavior of daily and weekly returns of five Indian stock market indices for random walk during April-1996 to June-2001. They have tested the indices for normality, autocorrelation using Q-statistic and Dickey-Fuller test and analyzed variance ratio using homoscedastic and heteroscedastic test estimates. Their results support that Indian stock market indices do not follow random walk. Rakesh Gupta and Parikshit K. Basu (2007) tested the weak form efficiency in the framework of random walk hypothesis for the two major equity markets in India viz, BSE and NSE for the period 1991 to 2006. The results suggested that the series do not follow random walk model and there is an evidence of autocorrelation in both markets which rejected the weak form efficiency hypothesis. Ashutosh Verma (2005) found evidence for that the Indian capital market is weak form efficient. This study was carried out on Bombay stock exchange for the period of 1996 to 2001 using serial correlation test. Pradhan B B and Mishra P K (2009) tested the efficiency of Indian capital market in its weak form by employing the unit root test. The study provides the evidence of weak form inefficiency of Indian capital market over the sample period. This study used the daily stock returns data computed from daily closing stock price index of Bombay Stock Exchange (BSE), i.e., Sensex for the time span covering March 2001 to March 2009. Saif Sadiqui and P.K.Gupta (2010) attempted to seek evidence for the weak form efficient market hypothesis using the daily data for stock indices of the National Stock Exchange for the

period of 1 January 2000 to 31 October 2008. They used non-parametric tests like Kolmogrov Smirnov normality test and run test and parametric tests like auto-correlation test, autoregression and ARIMA model to test weak-form efficiency. The results suggested that the market under study do not exhibit weak form efficiency. Sharma and Mahendru (2009) studied the weak-form efficiency of 11 securities listed on the BSE using weekly closing values from July 2007 to October 2007 by employing runs analysis and auto-correlation test. This study concluded that the Indian stock market (BSE in this case) is weak-form efficient. Khan, Ikram and Mehtab (2011) tested the efficiency of the Indian capital market using the daily closing values of the indices of NSE and BSE over the period from 1st April, 2000 to 31st March, 2010 by employing Runs Test. Based on the result of runs test alternate hypothesis is rejected and it is proved that Indian Capital market neither follow random walk model nor is a weak form efficient.