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ArthPrabhand:AJournalofEconomicsandManagement Vol.1Issue1,April2012,ISSN
A STUDY OF RANDOM WALK HYPOTHESIS OF SELECTED SCRIPTS LISTED ON NSE

DR.KEYUR M NAYAK*
*Associate Professor, Laxmi Institute of Management, Sarigam.
ABSTRACT For many years economists, statisticians, and teachers of finance have been interested in developing and testing models of stock price behavior. The random walk hypothesis (RWH) states that the present market price is the best indicator of the future market prices with an error term that is stochastic in nature. Hence the next time period price is anybodys guess. In an efficient market it is not possible to make profit based on the past information hence the prediction of future price conditional on the past prices on an average should be zero. The more efficient a market is the more random and unpredictable the market returns would be. The present study seeks to examine the random walk of share prices of the companies of various sectors. The secondary data had been collected from the NSE website and same had been tabulated tested using SPSS software to draw meaningful conclusion. It had been found that the companies in all the sectors follow the random walk due to the transparency and efficiency of the market. KEYWORDS: Random Walk, Transparency, Efficient market, Stochastic, Future market. ______________________________________________________________________________ INTRODUCTION PinnacleResearchJournals48 http://www.pinnaclejournals.com For many years economists, statisticians, and teachers of finance have been interested in developing and testing models of stock price behavior. One important model that has evolved from this research is the theory of random walks. This theory casts serious doubt on many other methods for describing and predicting stock price behavior- methods that have considerable popularity outside the academic world. For example, we shall see later that, if the random- walk theory is an accurate description of reality, then the various technical or chartist procedures for predicting stock prices are completely without value. In general, the theory of random walks raises challenging questions for anyone who has more than a passing interest in understanding the behavior of stock prices.1 The concept of efficient stock market has been hotly debated ever since Eugene Fama first introduced it around thirty-five years ago. Under the weak form of market efficiency, the price of a security reflects all the available information about the economy, the market and the specific security, and that prices adjust immediately to new information. For a long time the conformation of random walk is considered to be a sufficient condition for market efficiency. However, rejection of random walk model does not necessarily imply the inefficiency of stock-price formation. Random Walk is the path of a variable over time that exhibits no predictable patterns at all. If a price, p, moves in a random walk, the value of p in
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any period will be equal to the value of p in the period before, plus or minus some random variable. The random walk hypothesis (RWH) states that the present market price is the best indicator of the future market prices with an error term that is stochastic in nature. Hence the next time period price is anybodys guess. In an efficient market it is not possible to make profit based on the past information hence the prediction of future price conditional on the past prices on an average should be zero. The more efficient a market is the more random and unpredictable the market returns would be. In the most efficient market the future prices will be totally random and the prices formation can be assumed to be a stochastic process with mean in price change equal to zero. THE WEAK FORM The weak form says that the current prices of stock already fully reflect all the information that is contained in the historical sequence of prices. 2 Therefore, there is no benefit -as far as forecasting the future is concerned in examining the historical sequence of the prices. This weak form of the efficient market hypothesis is popularly known as random walk theory. Clearly, if this weak form of efficient market hypothesis is true, it is a direct repudiation of technical analysis. If there is no value in studying past prices and past price changes, there is no value in technical analysis. However technician place considerable reliance on the charts of historical prices that they maintain even though the efficient market hypothesis refute this practice. In short, weak form asserts that all past market prices and data are fully reflected in securities prices. In other words, technical analysis is of no use. THE SEMISTRONG FORM This form of efficient market hypothesis says that current prices of stocks not only reflect all information content of historical prices but also reflect all publicly available knowledge about the corporation being studied. Further more, the Semistrong form says that efforts by analyst and investors to acquire and analyze public information will not yield consistently superior return to analyst. Examples of public information that will not be of value on a consistent basis to the analyst are corporate reports, corporate announcements, and information relating to corporate dividend policy, forthcoming stock splits, and so forth. In effects, the his form of the efficient market hypothesis maintains that as soon as information becomes publicly available, it is absorbed and reflected in the stock prices. Even if this adjustment is not the correct one immediately, it will in a very short time be properly analyzed by the market. Thus the analyst would have great difficulty trying to profit using fundamental analysis. Further some, even while the correct adjustment is taken, the analyst cannot obtain consistent superior returns. Because the incorrect adjustment will not take place consistently; that is sometimes the adjustments will be over adjustments and sometimes they will be under adjustments. Therefore an analyst will not be able to develop a trading strategy based on these quick adjustments to new publicly available information. In short the Semi strong form asserts that all publicly available information is fully reflected in securities prices. In other words, fundamental analysis is of no use.
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THE STRONG FORM To test the strong form of efficient market hypothesis, even more indirect method must be applied. For the strong form no information is useful. This implies that not even security analyst and portfolio managers who have access to information more quickly than the general public. Therefore, many of the tests of strong form of the efficient market hypothesis deal with test of mutual-fund performance. In short this form asserts that all information is fully reflected in securities prices. In other words, even insider information is of no use. The paradox of efficient markets is that if every investor believed a market was efficient, then the market would not be efficient because no one would analyze securities! In effect, efficient markets depend on market participants who believe the market is inefficient and trade securities in an attempt to outperform the market! REVIEW OF LITERATURE Lo and MacKinlay (1988)i propose the variance ratio test for the random walk hypothesis. They apply the test on weekly returns in the New York Stock Exchange and American Stock Exchange and find evidence to reject the random walk model for the entire sample period of 1962 to 1985. According to the variance ratio test, the ratio of the variance of the q period returns to the variance of the one period returns divided by q must be equal to unity under the random walk hypothesis. Ayadi and Pyun (1994)ii also acknowledge that the variance ratio test is more appealing than other traditional tests for random walk. The multiple variance ratio test simply compares the maximum absolute value of the Lo and MacKinlay test statistics [namely [Z.sup.*.sub.j] (q) = max |Zj (q)| (j = 1 and/or 2)] with the studentized maximum modulus (SMM) critical values. The SMM table can be found in Hahn and Hendrickson (1971) and Stoline and Ury (1979). Pan, Chiou, Hocking, and Rim (1991)iii apply the variance ratio test on daily and weekly returns of five Asian stock markets: Hong Kong, Japan, Singapore, South Korea, and Taiwan from January 1982 to June 1987. The random walk hypothesis is rejected in all the sample countries except Japan.In addition, the variance ratios also indicate evidence of positive autocorrelation for all sample countries except Japan.Though much empirical research indicates the weak form of efficiency in Malaysia's Kuala Lumpur Stock Market, the results so far have been inconclusive and thus demand investigation. It is worth noting that Joy and Jones 1986 state that weak form tests are not direct tests of technical analysis. Despite the views on market efficiency, technical analysis is still considered to be a viable and efficient approach to individual stock selection and market analysis. Brock, Lakonishok, and Lebaron (1992) examined the predictability of technical trading rules such as the moving average rule and trading range breakout rule in the United States stock market from 1897 to 1986. They find that the buy (sell) signals generate returns that are higher (or lower) than normal returns. In addition, they also find that for both the variable length moving average (VMA) and fixed length moving average (FMA) rules, the conditional mean buy returns are significantly higher than the conditional mean sell returns prior to taking transaction costs. Hudson, Dempsey, and Keasey (1996) who apply the technical trading rules of Brock et al. (1992) in the United Kingdom (U.K.) stock market from July 1935 to January 1994, however, find that the technical trading rules did not generate excess returns after taking transaction costs of 1 percent per round trip. Bessembinder and Chan (1995) investigate the
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trading rules of Brock et al. (1992) in Hong Kong, Japan, Korea, Malaysia, Thailand, and Taiwan from 1975 to 1991. The results indicate strong forecast ability for the emerging markets of Malaysia, Thailand, and Taiwan. This is consistent with Dawson (1991) and Yong (1991) who find some price patterns in the Malaysian stock market. The presence of mean reverting tendency and absence of random walk in US stocks was confirmed by the studies of De Bondt & Thaler (1989)iv. The Lo & MacKinlay finding of positive autocorrelation was inconsistent with the negative serial correlation found by Fama & French (1988)v. Fama & French discovered that for the U.S. stock market, 40 percent of the variations of longer holding-period returns were predictable from the information on past returns. Parameswaran (2000)vi performed variance ratio tests corrected for bid-ask spread and nonsynchronous trading on the weekly returns derived from CRSP daily returns file for a period of 23 years. His results show that eight out of ten sizesorted portfolios do not follow a random walk. He observed that non-trading is not a source of serial correlation in the large sized firms. Kim, Nelson & Startz (1991)vii examined the random walk process of stock prices by using weekly and monthly returns in five Pacific-Basin stock markets. The findings provided evidence that the meanreversion was only a phenomenon of the pre-World War II period, and not a feature of the post-war period. They found that the variance ratio tests produced positive serial correlation. Studies based on the Lo & Mackinlays simple volatility based specification test have indicated rejection of random walk in the stock markets of developing countries and newly developed countries as well. Pan, Chiou, Hocking & Rim (1991) applied the variance ratio test on daily and weekly returns for a five-year sample period in five Asian stock markets, namely, Hong Kong, Japan, Singapore, South Korea, and Taiwan. They rejected the null hypotheses of randomness for both daily and weekly market returns for Korea and Singapore and accepted the null hypothesis in case of Japan. The null hypotheses for Hong Kong daily returns index and the Taiwan weekly returns index were also rejected. Their results indicated that all the returns based on the five market indices were positively auto correlated except for Japan. Barman & Madhusoodanan (1993) used variance ratio test to find out the temporary and permanent components in the stock market. Their study based on industry wise indices concluded that in general Indian market is mean reverting. Ayadi & Pyun (1994) showed that South Korean market does not follow random walk when tested under homoscedastic error term assumption and follows random walk when the test statistic is corrected for heteroscedasticity. In his further study Madhusoodanan (1998)viii concluded that RWH can-not be accepted for BSE sensitive index and BSE national index and observed that heteroscedasticity does not seem to be playing an important role in the Indian stock market. Ming, Nor & Guru (2000) showed that variance ratio and multiple variance ratio tests reject random walk for Kuala- Lampur stock exchange. They further show that trading rules like variable length moving average (VMA) and fixed length moving average (FMA) have predictive ability of earning profits over and above the transaction costs. Darrat & Zhong (2000) examined random walk hypothesis for the two newly created stock exchanges in China. They followed two different approaches-the variance ratio test and comparison of NAVE model (based on assumption of random walk) with other models like ARIMA and GARCH. They rejected the random walk in newly created Chinese stoke exchanges using both the methodologies. They further suggested artificial neural network (ANN) based models as strong tools for predicting prices in the stock exchanges of developing countries. Grieb & Reyes (1999) employed variance ratio on weekly stock returns to re-examine the Brazilian and Mexican stock markets. The findings indicated non-random behavior in the Mexican market while the Brazilian market
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indicated evidence in favor of the random walk. Koh & Goh (1994) tested the random walk hypothesis by extending the framework of Cochrane (1988) on Malaysian stock indices. The results revealed that the Malaysian stock market followed random walk in the long run. For a long time the empirical testing of the efficient market hypothesis was based on the rejection of forecast ability of asset returns. Ability of any model to predict future stock prices fairly accurately itself proves that the market does not follow random walk. The studies based on technical analysis and neural networks disprove random walk hypothesis by proving that future prices can be accurately forecasted. Mitra (2000)ix developed ANN model based on past stock market prices as parameters and showed that network performs very well in forecasting developments in BSE sensitive index, thus rejecting the criteria of un-forecast ability of stock prices in Bombay stock exchange. Ming, Nor & Guru studyx (mentioned 5 earlier) also tries to disprove random walk by establishing the predictive capability of technical rules like VMA and FMA. Well-known Dickey-Fuller unit root test and Box-Pierce Q tests are also widely used in literature. Ramasastri (1999)xi tested Indian stock markets for random walk during post liberalization period using three Dickey-Fuller hypotheses. Contrary to other studies he could not reject the null hypothesis that stock prices are random walks. RESEARCH METHODOLOGY RESEARCH DESIGN The study aimed to know the random walk of the different sectors of Indian economy; hence the research design of the study is descriptive in nature. SAMPLING The study spans ten years, starting from 01-04-2001 31-03-2011. The span of time period in sampling of data was restricted due to the availability of data Non-trading is not a major problem since market indices are bound to fluctuate (at least by a marginal value) on every trading day. The daily closing prices of respective scripts are used as the source data, which is used to arrive at conclusion. The return is calculated as the logarithmic difference between two consecutive prices in a series, yielding continuously compounded returns. OBJECTIVES The objectives of the study are as follows 1. To test the validity of RWH in the FMCG sector 2. To test the validity of RWH in the power sector 3. To test the validity of RWH in the infrastructure sector 4. To test the validity of RWH in the banking sector 5. To test the validity of RWH* in the automobile sector
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HYPOTHESIS To achieve the above objective, the following hypothesis have been formulated. 1. H0: The return series in FMCG sector is not random. 2. H0: The return series in power sector is not random. 3. H0: The return series in infrastructure sector is not random. 4. H0: The return series in automobile sector is not random. 5. H0: The return series in FMCG sector is not random. SOURCES OF DATA COLLECTION The secondary data had been collected from various journals, magazines, newspapers and NSE website. TOOLS OF DATA ANALYSIS Analysis of time series requires a stepwise procedure. The univariate time series has to be tested for stationerity. Usually, the non stationery series is transformed to eliminate factors like trends, heteroscedasticity etc. by using either log transformation or differencing. In this study, the returns have been expressed as the first difference of the time series: ET=In Pt-In Pt-I (Vandaele, 1983; Grenger, 1970) Where, Et = random error term or the residual of the time series at time t * RWH = Random Walk Hypothesis In Pt = stock price at time t PinnacleResearchJournals53 http://www.pinnaclejournals.com In Pt = stock price at time t-1 The next step requires determining whether the series is statistically independent or not. Runs test has been used for testing whether the returns are independent or not. For Runs test SPSS 16.0 version has been used and Z value is calculated. SIGNIFICANCE OF THE STUDY This study will be useful to the investors, Brokers, Stock market regulators, students of finance specialization and many other participants of capital market in India. DATA ANALYSIS AND FINDINGS In this study, daily observations of 31 stocks of companies from different sectors were selected for study. All these companies are listed on National Stock Exchange. The Runs test was performed on the stocks and the results of the test is given in the following tables.
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TABLE 2 AUTOMOBILE SECTOR Sr. No 1 2 3 4 5 6 Name of the Company Tata Motors M and M Maruti Suzuki Bajaj Auto Hero Honda Ashok Leyland No of Runs 298 42 46 06 60 29 Z Value -48.969 -48.380 -42.521 -26.232 -47.639 -48.859 Asymp.Sig (2) tailed 0.000 0.000 0.000 0.000 0.000 0.000
When we talk about stocks from automobile sector it is found that all the p values are less than 0.05 which reject the null hypothesis. Therefore we can conclude that stocks do not follows particular pattern, Even though fundamentals analysis of automobile sector gives us clear picture that with increasing income of Indian middle class the demand for various automobiles will increase. From this we can say that prices of all scrips cannot be predicted by using historical information of these stocks. The scrips of all companies reject the null hypothesis that is the return series in automobile sector is not random. This means that future prices of these stocks cannot be predicted because they follow random walk. Here historical prices or information is not useful at all for predicting future prices. In all the cases p values are less than 0.05 which reject the null hypothesis. In case of power sector, all the companies do not follow certain pattern and so its follow random walk. Scrips of all the power sector company reject the null hypothesis that is the return series in power sector is not random. Prices of the above companies cannot be predicted by using historical prices. Investor cannot get benefit of past prices of the companies of this sector. TABLE 3 POWER SECTOR Sr. No 1 2 3 4 5 Name of the Company Tata Power Reliance Energy GVK Jaiprakash Power Ltd Birla Power No of Runs 14 42 32 22 24 Z Value -32.981 -24.890 -33.737 -37.432 -32.981 Asymp.Sig (2) tailed 0.000 0.000 0.000 0.000 0.000
In all the 9 companies p values are less than 0.05 which reject the null hypothesis that the return series in FMCG sector is not random. Scripts of all the FMCG sector does not follow certain
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pattern in its prices therefore investor cannot predict its prices and cannot get benefit of past pieces. TABLE 4 FMCG SECTOR Sr. No 1 2 3 4 5 6 7 8 Name of the Company Marico Agro Tech Food Ltd Colgate Godrej products Ltd Wipro Dabur India Ltd P&G Nestle No of Runs 24 56 10 22 34 49 52 04 Z Value -48.967 -48.730 -27.881 -49.826 -48.700 -48.069 -44.449 -17.294 Asymp.Sig (2) tailed 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Infrastructure sector is growing very fast now days in Indian economy. The result of this study indicates that scrip prices of companies from this sector cannot be predictable as the return series in infrastructure sector is not random. So the investor cannot predict the price of this sector companies on the basis of its past prices as its follow random walk. PinnacleResearchJournals55 http://www.pinnaclejournals.com TABLE 5 INFRASTRUCTURE SECTOR Sr. No 1 2 3 4 5 6 Name of the Company GMR Infrastructure BSEL Infrastructure Reliance Infrastructure GTL Infrastructure Ruchi Infrastructure PBA Infrastructure No of Runs 12 36 56 56 48 42 Z Value -33.217 -46.369 -47.789 -29.663 -39.597 -34.234 Asymp.Sig (2) tailed 0.000 0.000 0.000 0.000 0.000 0.000
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TABLE 6 BANKING SECTOR Sr. No 1 2 3 4 Name of the Company ICICI Bank HDFC Bank Union Bank of India State Bank of India No of Runs 54 24 48 82 Z Value -49.791 -49.080 -44.921 -51.165 Asymp.Sig (2) tailed 0.000 0.000 0.000 0.000
In banking sector also ICICI Bank, State Bank of India, HDFC Bank and Union Bank of India reject the null hypothesis that is the return series in banking sector is not random. This means in case these banks price prediction is very difficult because they follow random walk. Investors cannot get any kind of benefit from historical price information. In all the companies p values are less than 0.05 which reject the null hypothesis. When we talk about all the companies under study, we can say that all the companies reject the null hypothesis. From 31 scrips of different companies all scripts follows random walk. From the study it is found that around 100% of the scripts follow random walk .It is evident from the study that historical information of prices of different scripts is not useful for predicting future prices. Stocks from automobile sector it is been found that all the stocks do not follows particular pattern, Even though fundamentals analysis of automobile sector gives us clear picture that with increasing income of Indian middle class the demand for various automobiles will increase. In case of power sector, it is been found that all the companies do not follow certain pattern and so its follow random walk. Scripts of all the power sector company reject the null hypothesis that is the return series in power sector is not random. PinnacleResearchJournals56 http://www.pinnaclejournals.com In FMCG sector it is been found that scripts of all companies rejected the null hypothesis that is the return series in FMCG sector is not random. Scripts of all the FMCG sector does not follow certain pattern in its prices therefore investor cannot predict its prices and cannot get benefit of past pieces. In case of Infrastructure sector it is been found that the scrip prices of companies from this sector cannot be predictable as the return series in infrastructure sector is not random. So the investor cannot predict the price of this sector companies on the basis of its past prices as its follow random walk.
In banking sector also it is been found that ICICI Bank, State Bank of India, HDFC Bank and Union Bank of India reject the null hypothesis that is the return series in banking sector is not random. This means in case these banks price prediction is very difficult because they follow random walk. Investors cannot get any kind of benefit from historical price information.
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CONCLUSIONS & SUGGESTIONS The returns of all the scrips which are examined in this study can not be predicted by the investors by using the historical information of the scrips. The reason being that scrips of these companies do not follow certain pattern. Taking into consideration the objectives of the study the following conclusion can be drawn. TABLE 7 SUMMERY OF RUNS TEST RESULT Sector Follow Certain Pattern Automobile Sector Power Sector FMCG Sector Infrastructure Sector Banking Sector Total 0 0 0 0 0 0 6 5 9 7 4 31 6 5 9 7 4 31 Follow Random Walk Total
The stock prices of a substantial number of selected stocks listed on NSE have rejected the null hypothesis. This implies that these stocks could not be predicted by using historical prices. In other words the technical annalist could not play an important role in framing investment strategy. However the majority of the scrips follow random walk. Here technical analyst can play an important role. Investors can be benefited by the study. The study gives investors an idea about the companies, which are preferable to them for investment. It helps them to find out the companies where trends are repeated in future. It can be seen that the majority of the scrips i.e. 100% are pursuing random walk. They cannot earn abnormal return from their investment in those scrips. This finding helps them to take wiser investment decisions. All the companies in the entire sector do follow the random walk of share price. Hence this may be due to the strong form of Indian Capital Market. This may be due to information symmetrical. The EMH states that it would be impossible to consistently outperform the market in an environment characterized by many competing investors, each with similar objectives and equal access to same information. Thus, if the markets are efficient then trying to pick up winners for investment purpose will be a waste of time. On the other hand if the markets are not efficient, then excess returns can be made by correctly picking the winners. If the stock prices are not independent, it is possible to obtain increased profits on the basis of price change predictions. The study adopted runs taste in five sectors to find whether random walk hypothesis is valid in them or not. The result shows that
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random walk hypothesis is valid in all the cases of companies from all sectors. The empirical results shown here are tentative and further research is needed to address the issue. SUGGESTIONS It is advisable to the financial analyst and investors that in all the five sector price are random and cannot be manipulated therefore they can relied on the efficiency of the market and the information asymmetry of the companies. The market is in its strong form hence transaction can be made with confidence in the market and market intermediaries. There are less chance for the speculative activities in the markets as it is difficult to forecast the future price based on past data.
i Lo, A. W., and MacKinlay, A. C., 1988, Stock Market Prices do not Follow Random Walks: Evidencefrom a Simple Specification Test, The Review of Financial Studies, Vol. 1, No. 1, 4166. ii Ayadi, O. F., and Pyun, C. S., 1994, An application of variance ratio tests to the Korean securities market, Journal of Banking and Finance, 18, 643-658. iii Pan, M.S., Chiou, J.R., Hocking, R., and Rim, H.K., 1991, An examination of meanreverting behaviour of stock prices in Pacific-Basin stock markets, Pacific-Basin Capital Markets Research, 2, 333-342.15 iv De Bondt, W, and Thaler, R. H., 1989, Further Evidence on Investor Overreaction andStock Market Seasonality, Journal of Finance, 42, pp. 557-581 PinnacleResearchJournals58 http://www.pinnaclejournals.com v Fama, E. F., and French, K.R., 1988, Permanent and temporary components of stock prices, Journal ofPolitical Economy, 96(2), 246-273. vi Parameswaran, S. K., 2000, A Method of Moments Test of the Random Walk Model in the Presence of Bid-ask Spreads and Non-synchronous Trading, Applied Finance, Vol. 6, No. 1, 1- 22. vii Kim, M. J., Nelson, R. C., and Startz, R., 1991, Mean reversion in stock prices? A reappraisal of theempirical evidence, The Review of Economic Studies, 58, 515-528. viii Madhusoodanan, T. P., 1998, Persistence in the Indian Stock Market Returns: An Application of Variance Ratio Test, Vikalpa, Vo l 23, No. 4, 61-73. ix Mitra, S. K., 2000a, Forecasting Stock Index Using Neural Networks, Applied Finance, Vol. 6, No. 2, 16-25.
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x Ming, L. M., Nor, F. M., and Guru, B. K., Random Walk and Technical Trading Rules: Some Evidence from Malaysia, 2000. xi Ramasastri, A. S., 1999-2000, Market Efficiency in the Nineties: Testing through Unit Roots, Prajnan, Vol. XXVIII, No. 2, 155-161.

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A STUDY OF RANDOM WALK HYPOTHESIS OF SELECTED SCRIPTS LISTED ON NSE

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