Summary and Conclusion

Summary and Major Findings

The past two decades have witnessed important policy reforms aimed at
liberalisation and globalisation of the Indian economy. To achieve an efficient,
transparent and vibrant financial sector in general and stock market in particular,
several financial sector reforms, changes in market microstructure and trading
practices were introduced. The Capital Issues (Control) Act 1947 was repealed and
pricing of financial assets was liberalized. As a part of market reforms, new stock
exchange was established, and the existing stock exchanges were demutualized
and exchanges adopted screen-based automated trading. The National Stock
Exchange (NSE) and Bombay Stock Exchange (BSE) launched several new
financial products and SEBI was set up as the regulator of capital market. As
results of these reforms, Indian stock market has registered a notable growth in
terms of listed companies, trading volume and emerged as one of the favourite
destination of investment. Against the back backdrop of these reforms and
changes, a study of behaviour of stock returns, particularly, analysis of efficiency
of stock market in a liberalized environment assumes significance.
Various schools of thought have theorized the behaviour of stock returns. The
Neo-classical School of Finance proposes a theory of efficient market or efficient
market hypothesis (EMH) based on rational expectation and no-trade argument.
Eugene Fama, one of the main architects and advocates of the theory, provided
strong theoretical foundations and a framework to test the EMH empirically. In an
informationally efficient market, prices quickly absorb new information and reflect
all the available information instantly in such a way that such price processing
mechanism does not provide extra normal returns. In other words, there is no
possibility of predictability of returns by using the history of returns and a simple
buy and hold strategy would do well in such an informationally efficient market.
The vital functions of stock market such as optimal allocation of capital and
facilitation of climate conducive to investment would have adverse effects if
market were inefficient. Therefore, the study of efficiency assumes importance.
The large body of research conducted in the last three decades itself reflects the
importance of the informational efficiency of stock market. Various methods are

G. S. Hiremath, Indian Stock Market, SpringerBriefs in Economics, 111

DOI: 10.1007/978-81-322-1590-5,  The Author(s) 2014
112 Summary and Conclusion

employed in empirical studies to test different forms of market efficiency. Random

walk hypothesis is considered one of the effective and convenient ways to test
weak form of efficiency. In an efficient market, returns are expected to respond
randomly to new information and therefore it is not possible to predict future
returns based on past memory of prices. The early studies of 1960s and 1970s
supported the view that stock returns follow a random walk. There was a paradigm
shift in post 1987 studies, which reported nonlinear dynamics in stock returns. The
conventional tests of market efficiency found to be incapable of capturing such
dynamics. Concomitant to this, long memory properties of stock returns have
gained particular attention over the last decade in finance.
In the light of the above factors, the main purpose of the present volume was to
examine the returns behaviour in Indian equity market in the changed market
environment. The book primarily focused on weak form of efficiency. In this work,
the random walk hypothesis was empirically tested and the volume addressed issues
such as nonlinear serial dependence mean reversion, and long memory in stock
returns. The data used in the study consists of daily stock index returns of NSE and
BSE, the major stock exchanges in India. Eight indices including three sectoral
indices from the NSE and six indices from the BSE were chosen. The study has made
improvements from previous studies in terms of the application of sophisticated
tests, updated, comprehensive and disaggregated dataset, addressing issues which
have not received due importance in previous research on Indian stock market.
This study empirically tested whether stock returns in India follow a random
walk. Towards this end, data on major indices during the period June 1997–March
2010 are analysed using both parametric and non-parametric tests, some of which
are not employed in previous studies in India. The results from parametric tests
offered mixed evidence. The parametric test results suggest significant rejection of
random walk hypothesis in case of smaller stock indices with lower market
capitalization and liquidity. The evidence of rejection of random walk behaviour in
stock returns of large cap and high liquid indices are weaker as the investment
horizon increases. Non-parametric tests, which are considered appropriate when
returns are non-normal, have shown rejection of hypothesis that increments are
independent and identically distributed for the selected index returns and these
results are not sensitive to the composition of index. The rejection of random walk
at longer horizon implies that the information in short-horizon is not instantly
reflected in returns and thus provides opportunity for excess returns to those who
have access to information. Later, as time horizon increases, trading strategies of
those who had access to such information began to reflect in prices leading the
market towards efficiency.
Nonlinear dependence in returns directly contrasts the EMH since such
dependence structure provides potential opportunities for prediction. In view that
there has not been much empirical work in the case of India, the present study has
applied a set of nonlinearity tests which have different power against different
classes of nonlinear process, to uncover nonlinear dependence in stock returns of
selected indices. The tests results provide strong evidence of nonlinear serial
dependence in stock returns for full sample period. However, the windowed test
Summary and Conclusion 113

procedure applied in the study shows a nonlinear structure that is not consistent
throughout the full sample period but confined to a few sub-periods thus
suggesting episodic nonlinear dependence surrounded by long periods of pure
noise. Furthermore, it is found that both negative and positive events were
associated with these nonlinear dependence periods, but negative events had a
significant effect. The episodic presence of nonlinear dependence implies that
certain events induce such nonlinear dependence. The major events identified were
uncertainties in international oil prices, volatile exchange rates, turbulent world
markets, sub-prime crisis, global economic meltdown and political uncertainties,
especially border tensions. Though the nonlinear dependence found in stock
returns indicates predictability of stock returns, investors find it difficult to exploit
such dependence to forecast, because it is not present throughout the sample period
but just confined to a few periods. The episodic dependence in returns indicates
that investors take time to learn about shock and adjust their trading strategies.
The mean-reversion hypothesis is tested as an alternative explanation for the
behaviour of stock returns to random walk behaviour. The conventional unit root
tests results may mislead in the presence of structural breaks. Therefore, multiple
structural breaks tests are carried out and two significant structural breaks in each of
the index series are found. The test results have shown rejection of null of unit root,
thus clearly indicating trend-stationary process. The study identified the events
associated with significant structural break dates. The dot.com bubble burst and
consequent recession in the USA, bad monsoons, international oil shocks, volatile
exchange rates, sub-prime crisis and global economic meltdown, fluctuations in
foreign institutional investment, political uncertainties including border tensions are
the major events identified around significant trend breaks. The study found that
smaller cap indices were more vulnerable to external shocks than large cap indices.
The long memory in stock returns is important because it explains the returns
behaviour. To detect long memory in mean returns, the study has carried out multiple
semi-parametric tests. The study has largely found the presence of long memory in
mean returns. The anti-persistence evidence observed in index returns is not
consistent. The findings of the study did not support the relative size proposition. In
the same fashion, this study endeavoured to detect long memory in volatility. The
model estimates indicate strong evidence of long memory in volatility. In other
words, this study has found that the FIGARCH model better describes the persistence
of volatility than the conventional models of volatility. The evidence of long memory
in both mean and volatility suggests that using linear modelling would result in
misleading inferences. The evidence of long memory suggests proper factoring of
long memory volatility in derivative pricing and risk management models.

Implications of the Study

To conclude, study largely suggests rejection of random walk hypothesis in Indian

stock market. This implies that Indian equity market is not weak form efficient.
114 Summary and Conclusion

The results indicate no significant difference in the behaviour of index returns

between the NSE and BSE. Nevertheless, the stock indices having higher liquidity
and market capitalization prove to be less inefficient than small indices on both the
exchanges. Furthermore, the small indices with less liquidity appear to be more
vulnerable to external shocks. Sectorwise, there has not been much difference. In
the light of the present evidence, it is clear that policy reforms aimed at improving
the efficiency have not brought the desired results.
In view of the above discussion, some policy implications are proposed here.
The evidence of existence of potential excess returns in short horizons of
investment calls for policy measures aiming at proper dissemination of
information to the participants. This has further support from the episodic
nonlinear dependence, which suggests that investor takes time to respond to the
events. Further, to improve the performance of small indices having lesser
liquidity, it is important to improve the liquidity of smaller stocks. Encouraging
retail trading and promoting the mutual funds in the Indian market may achieve
this. RBI’s initiative for financial literacy and NSE’s certificate courses for
financial education are welcoming steps in this direction. External events have
always created panic in the Indian stock market. Whenever there were some
shocks , there was net outflow of FIIs. In the light of this, policy measures aiming
at an appropriate management of external sector and global events need to be
initiated in order to improve the immunity of stock market towards ill effects of
global shocks. There is also need of optimal regulation of FIIs and pressing for
further disclosures from the FIIs. In light of the current empirical evidences, before
hastening for the third generation reforms, a pause for a holistic review of financial
sector reforms is important at this crucial juncture.
The limitations of the study highlight scope for further research. The study
indicated stronger rejection of market efficiency and vulnerability of Indian stock
market to external shocks. The interaction between market microstructure
variables and market efficiency indicators may throw further light. A further
investigation of sources of long memory and a causal analysis of inefficiencies
would provide useful information for policy measures.
The empirical evidence presented in this book resoundingly rejects the EMH.
From the theoretical perspective, there are no convincing explanations for non-
random walk behaviour in stock returns. According to Andrews Lo, perfect
efficient market is difficult to find in real world and he advocates the engineering
notion of ‘‘relative efficiency’’ of market as a useful concept. Using the evolution
of human behavioural principles, Lo proposes adaptive market hypothesis,
according to which market efficiency evolves over a period. In this framework,
rational EMH co-exists with behavioural models in an intellectually consistent
manner. Future research on Indian stock market could focus on these aspects.
About the Author

Gourishankar S Hiremath is Assistant Professor of Economics & Finance at Indian

Institute of Technology Kharagpur (India). He previously worked at Indian
Institute of Technology Jodhpur, Gokhale Institute of Politics and Economics,
Pune, and ICFAI Business School-Hyderabad. He holds a PhD in Financial
Economics from University of Hyderabad, India and his areas of specialisation
include Indian Capital Market, International Finance, Financial and Commodity
Derivatives, and Applied Time Series Econometrics. He has presented his papers
both in National and International conferences and published research papers in
some leading journals. He has done research for National Bank for Agriculture and
Rural Development (NABARD) and Climate Works Foundation, New Delhi. He is
member of Panel of Experts, Young Entrepreneurs Incentive Scheme of Rajasthan
Financial Corporation sponsored by the Council of State Industrial Development
and Investment Corporations of India.

G. S. Hiremath, Indian Stock Market, SpringerBriefs in Economics, 115

DOI: 10.1007/978-81-322-1590-5,  The Author(s) 2014
Index Description

BSE Sensex

BSE Sensex represents large and financially sound 30 companies across key
sectors. It accounts for about 45 % of total market capitalization on BSE.

BSE 1001

BSE 100 index is made up of 100 companies listed on five important stock
exchanges in India. The scripts included are of those companies that have been
traded more than 95 % trading days and figured in final 200 ranking.2 BSE 100
stocks represent about 73 % of market capitalization.

BSE 200

Equity shares of 200 selected companies from the specified and non-specified lists
of BSE constitute BSE 200 index. It represents 82.70 % of market capitalization
on BSE.

BSE 500

BSE 500 constitutes about 94 % of market capitalization on BSE. It covers major

20 industries of the company. The stocks which are included in BSE 500 are those
which have traded 75 % days and figured in top 750 companies in final ranking.

1
BSE 100 was formerly known as BSE National Index.
2
BSE arrives at this ranking base on 3 months full market capitalization of stock and liquidity
which are given 75 and 25 % of weight respectively.

G. S. Hiremath, Indian Stock Market, SpringerBriefs in Economics, 117

DOI: 10.1007/978-81-322-1590-5,  The Author(s) 2014
118 Index Description

BSE Midcap

This index constitutes medium-sized stocks and represents about 16 % of total

market capitalization on BSE.

BSE Smallcap

It accounts for about 6 % of market capitalization and made up of small-sized

stocks.

S & P CNX Nifty

It represents most liquid and well-diversified 50 stocks traded at NSE representing

22 sectors of the economy. Its percentage to total market capitalization is about
65 % on NSE.

S & P CNX Defty

CNX Defty is nothing but CNX Nifty, measured in dollars. This index is to
facilitate FIIs and off-shore fund enterprises.

CNX Nifty Junior

CNX Nifty Junior consists of next 50 liquid stocks excluded from CNX Nifty and
represents about 10 % of total market capitalization on NSE.

CNX 100

Diversified 100 stocks representing 35 sectors of the economy constitute CNX 100
index. It represents 75 % of total market capitalization on NSE
Index Description 119

CNX 500

CNX 500 equity index is broad-based index and accounts 95 % of total market
capitalization. The companies included are disaggregated into 72 industry indices.

CNX IT

Companies that have more than 50 % of their turnover from IT-related activities
are compressed in CNX IT. The CNX IT Index stocks represent about 80.33 % of
the total market capitalization of the IT sector as on March 31, 2010. Companies
included in CNX IT have at least 90 % trading days and ranked less than 500
based on market capitalization. This index accounts 14 % of total market
capitalization on NSE.

CNX Bank Nifty

The most liquid and large market capitalised 12 Indian Banking stocks traded on
NSE comprises CNX Bank Nifty. The CNX Bank Index stocks represent about
87.24 % of the total market capitalization of the banking sector and about 8 % of
the total market capitalization on NSE.

CNX Infrastructure

CNX Infrastructure index includes 25 stocks of companies belonging to Telecom,

Power, Port, Air, Roads, Railways, Shipping and other Utility Services providers.
CNX Infrastructure Index constituents represent about 21.43 % of the total market
capitalization on NSE.
Index

A C
Abnormal returns, 1, 2, 4, 19 Capital market, 8–10
Adaptive market hypothesis, 114 Chow and Denning Test, 89
ADF unit root, 22, 90 Competitive market, 2, 3, 5
AGBR test, 94 Conditional heteroscedasticity, 42, 51, 100
Allocation of resource, 2, 111 Conditional variance, 100, 102, 105
Anomalies, 20 Correlation, 44, 65, 87, 102
Anti-persistence, 94, 96 Covariance stationary, 86, 88, 103, 105
Arbitrage, 5, 6, 86, 100 Credit, 8, 52, 55
ARCH model, 102 Crisis, 8, 12, 52, 55, 72, 100
ARFIMA, 87, 88, 91, 100, 102, 103
Asian financial crisis, 56, 100
Asymmetric, 0 D
Asymmetry, 91 Daily prices, 103
Asymptotic, 89, 93 Daily returns, 43, 103
Autocorrelation, 13, 41, 43, 85, 87, 100, 102, Daily values, 15, 102, 103
103, 107 Dependence, 41, 42, 44, 89, 91, 100, 101
Autocovariance, 13, 85, 87 Derivative pricing, 13, 86, 100
Autoregressive, 87, 88, 100, 102, 103 Deterministic, 65
Autoregressive integrated moving average Dickey-Fuller, 61
(ARIMA), 87 Difference stationary, 67, 73
Distribution, 6, 7, 103
Dot com bubble, 11
B
Behavior, 89
Behavioral School, 6 E
Behaviour of stock returns, 37, 111, 113 Economic reforms, 8, 62, 102
Bicorrelations, 44, 46 Efficiency, 9, 13–15, 47, 73, 76, 81, 90
Binomial expansion, 88 Efficient equity market, 2
Bispectrum, 43, 45 Efficient market hypothesis, 1, 3, 5, 6, 41, 59,
Bombay Stock Exchange (BSE), 9, 12, 14, 15, 60, 73, 86
41, 43, 47, 51, 52, 54, 55, 62, 67, 70–73, Efficient Market Theory, 1, 2, 2, 3, 5, 6
76–78, 81, 86, 91, 94, 96, 101–105 Emerging market, 10, 11, 42, 53, 61, 62, 90,
Broack, Dechert, Sheinkman, LeBaron (BDS), 91, 101, 102
42, 44, 46, 47 Endogenous, 59, 61, 66
Brownian motion, 7, 86, 100 Episodic, 1, 42, 44, 47, 56

G. S. Hiremath, Indian Stock Market, SpringerBriefs in Economics, 121

DOI: 10.1007/978-81-322-1590-5,  The Author(s) 2014
122 Index

Equilibrium return, 3 I
Equity market, 2, 9–11, 13, 14, 53, 55, 73, 81, IID, 75–77, 81
90, 99 Independence, 7, 41, 42, 44
Events, 2, 41–43, 47, 51–56, 60, 66, Independent and identically distribution, 2, 7,
73, 76, 81 45, 112
Excess returns, 3, 5, 76, 81 India, 8–14, 42, 43, 52, 53, 55, 61, 62, 71–73,
Exchange rate, 42, 52, 59, 62 78, 81, 86, 91, 100, 102
Exogenous, 60, 64 Information, 1–6, 46, 53, 59, 60, 63, 76, 81,
Expected returns, 3, 7 86, 91
External events, 59, 73, 81 Information asymmetry, 91
External shocks, 73, 78, 81 Informational efficiency, The, 12, 13
Informationally efficient, 2
Informationally efficient market, 2, 5
F Insider trading, 21
Financial system, 1, 8 Integrated generalized autoregressive condi-
Forecast, 3, 13, 42, 56, 86, 99 tional heteroskedasticity (IGARCH), 103,
Foreign Direct Investment (FDI), 53 105, 107
Foreign Institutional Investors (FIIs), 9, 10, 52, Integration, 2, 89, 91
72, 73 International oil prices, 41, 52, 53, 55, 56, 59,
Foreign investors, 90 67, 72
Fractional integration, 89, 91, 95, 109 Investors, 2, 3, 5, 6, 9, 10, 14, 42, 90, 99, 100
Fractionally differenced, 100 Irrational, 6
Fractionally integrated generalized autore-
gressive conditionalheteroskedasticity
(FIGARCH), 100, 102–105, 108 K
Frequency domain, 43, 87, 90 Kurtosis, 29, 30
Frictions, 90, 99
Fundamental School, 6
L
Lagrange Multiplier, 61, 62
G Large cap, 72
Gaussian, 91, 93, 94 Lee-Strazicich test, 62, 67, 71, 72
Generalized autoregressive conditional Leptokurtic, 0
heteroskedasticity (GARCH), 100, Liberalization, 10
102–105, 107 Linear dependence, 13, 41, 44
Geweke Porter-Hudak semiparametric test Liquidity, 1, 8, 11, 14, 53, 55, 59, 72,
(GPH), 86, 89, 90, 92–94 73, 76, 91
Global economic meltdown, 41, 55, Ljung and Box, 105
56, 67, 72 Lo and MacKinlay Test, 74
Global meltdown, 59, 72 Long horizons, 37, 75, 76
Global recession, 55, 59 Long memory, 1, 13, 16, 91, 93, 94, 96,
Globalization, 7 100–102, 104, 105, 107, 108
Great Depression, 60 Long memory in volatility, 13, 14, 16,
100–102, 107
Long-range dependence, 13, 14, 85–87, 89, 90,
H 94, 100
Heteroscedastic, 25, 26, 32–34
Heteroscedasticity, 76, 89, 100
Hinich bicorrelation test, 47 M
History of stock returns, 3 Macroeconomic, 4, 6
Homoscedastic, 25, 26, 32–34 Market capitalization, 2, 8, 10, 11, 14, 22, 37,
Hurst, 87, 88, 90 55, 59, 67, 72, 76, 81
Hyperbolic, 13, 100, 102, 103, 107 Market crash, 42, 90
Index 123

Market microstructure, 1, 7, 9, 13, 14, 43, Q

51, 62, 73, 100
Martingale hypothesis, 42
Martingale process, 78, 81, 86, 100
McLeod and Li test, 43–47
Mean reversion, 13, 15, 20, 59–62, 65, 66, 73,
100
Memory, 13, 75, 85–91, 100–102, 105, 107,
108
Microstructure, 1, 7, 9, 12, 13, 43, 51, 62, 73,
100, 108, 111, 114
Mid cap, 67
Moving average, 6, 87, 88, 100, 102
Multiple variance ratios, 26
N 90, 100
National Stock Exchange (NSE), 9, 19, 20, 35,
37, 41, 43, 46, 51, 52, 55, 62, 72, 73, 75,
77, 78, 86, 91, 94, 96, 100
Noise, 20, 44, 46, 47, 51, 56, 88
Nonlinear, 13
Nonlinear dependence, 1, 13, 15, 28, 41–45,
47, 51, 55, 56
Nonlinear dynamics, 112
Non-normality, 37, 41, 89, 92, 94
Non parametric tests, 37
Non-stationary, 59, 105
Normal distribution, 25, 27, 28, 30, 94, 103
Normality, 25, 27, 28, 30, 74, 86, 93, 103, 111
Null hypothesis, 25, 30, 35, 44, 46, 65,
74, 75, 105
Q statistic, 105
Q test, 0
Quasi-maximum likelihood estimate, 104
R
Random walk, 7, 13, 19–26, 30, 32, 35, 37, 42,
43, 59, 60, 62, 73, 76–78, 81, 89
Random walk hypothesis, 7, 13, 15, 19,
46, 60, 85
Random walk model, 6, 20, 21, 23, 89
Random walk process, 2, 21, 24, 86
Rational, 5, 6, 21
Rational expectation, 3, 20
Reforms, 1, 8–10, 12, 13, 23, 52, 56, 62, 73,
Regulatory, 9, 19, 37, 42, 59, 61, 76, 90
Relative efficiency, 14
Relative size hypothesis, 107
Relative size proposition, 113
Rescaled range statistic, 87
Reserve Bank of India (RBI), 52–55, 66
Retail trading, 73
Returns, 1–7, 13–15, 19–25, 27, 28, 30, 32, 34,
35, 37, 41–47, 51, 53–56, 59, 60, 62, 65,
66, 72, 73, 75, 78, 81, 87–91, 93, 94, 96,
100–103, 105, 107
Risk management, 9
Robinson’s Gaussian semiparametric estima-
tion (RGSE), 94, 96
Runs test, 23, 27, 34, 35
Runs tests, 41

O
Oil prices, 54, 72 S
Oil shock, 60 Scam, 41, 52, 55, 56
Sector, 1, 7–9, 12, 14, 15, 22, 28, 37, 53, 72,
73, 81, 89, 100
P Sectoral, 9, 22, 30, 32, 35, 89
Paradigm shift, 42, 112 Securities and Exchange Board of India
Parametric, 15, 19, 28, 34, 35, 37, 65, (SEBI), 9, 53, 54, 66, 72
88–91, 94 Semi-parametric, 113
Periodogram, 92–94 Semi-strong form efficiency, 4
Persistence, 7, 13, 43, 89, 90, 100, 103, Serial dependence, 21, 22, 32, 42, 43
105, 107 Serially correlated, 20
Portfolio management, 100 Short horizons, 37, 75, 76
Portmanteau, 24, 27, 43, 44 Size distortions, 22, 26, 61
PP test, 65 Skewness, 44, 45
Predictable/Predictability, 2, 3, 20, 21, 86 Small cap, 55, 67
Price, 2, 3, 5–8, 19–21, 24, 37, 54, 60, South East Asia, 52
61, 72, 89, 91, 100, 103 Spectral, 21, 23, 87, 92, 93
Private incentive, 5 Stationarity, 61, 66, 67, 72, 73, 96
124 Index

Stationary, 43, 44, 59, 60, 65, 72, 85, 87, 92, U
103 Unconditional heteroscedasticity, 7
Stochastic process, 24 Unit root, 60–65, 67, 72, 73, 90, 103
Stock market, 6, 11–15, 19, 22, 23, 37, 42, 43,
53, 54, 59, 61, 78, 81, 85, 89–91, 99–105
Strong Form Efficiency, 4 V
Structural breaks, 1, 13, 16, 59, 62, 66, 67, Value at risk, 13, 100
71–73, 76–78, 81, 101 Variance, 7, 13, 22, 24, 25, 42, 64, 74, 75, 88,
Structural breaks, 60 100–102
Stylized fact, 30, 42, 60, 103 Variance ratio, 21, 22, 24–26, 32, 35, 41, 60,
Sub-prime crisis, 10, 41, 55, 56, 59, 67, 72, 73 73–76
Volatility, 10, 13, 30, 32, 52, 53, 99–103, 105,
107, 108
T Volatility forecast, 99
Technical analysis, 6
Technical school, 6
Thin trading, 21–23 W
Time domain, 87, 94 Weak form of efficiency, 4, 77
Time series, 13, 15, 20, 23, 41, 44, 59, 61, Windowed, 42, 43, 51, 52, 55
85–87, 89, 91, 93 Wright test, 74, 75
Time varying, 21
Transaction costs, 5
Trend, 55, 59, 61–65, 67, 72, 73, 78, 103 Z
Trend-stationary, 63 Zivot-Andrew test, 66, 67, 71
Tsay test, 44–46
Turnover ratio, 10, 11